UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2020
or
[   ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission File Number: 001-33652
FIRST FINANCIAL NORTHWEST, INC.
(Exact name of registrant as specified in its charter)
Washington		26-0610707
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
201 Wells Avenue South, Renton, Washington		98057
(Address of principal executive offices)		(Zip Code)
Registrant’s telephone number, including area code:		(425) 255-4400

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.01 par value per share	FFNW	The Nasdaq Stock Market, LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 

YES    X   NO      

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

YES    X   NO      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer _____	Accelerated filer    X	Non-accelerated filer _____
Smaller reporting company    X	Emerging growth company _____

        If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. _____

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES       NO   X   

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: as of August 4, 2020, 10,036,361 shares of the issuer’s common stock, $0.01 par value per share, were outstanding.

FIRST FINANCIAL NORTHWEST, INC.

FORM 10-Q

TABLE OF CONTENTS

			Page
PART I - FINANCIAL INFORMATION
	Item 1.	Financial Statements	3
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	62
	Item 4.	Controls and Procedures	65
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings	66
	Item 1A.	Risk Factors	66
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	67
	Item 3.	Defaults upon Senior Securities	67
	Item 4.	Mine Safety Disclosures	67
	Item 5.	Other Information	67
	Item 6.	Exhibits	68
SIGNATURES			69

2

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollars in thousands, except share data)

Part 1. Financial Information

Item 1. Financial Statements

	June 30, 2020		December 31, 2019
Assets
	(Unaudited)
Cash on hand and in banks	$	7,688	$	10,094
Interest-earning deposits	66,250		12,896
Investments available-for-sale, at fair value	128,874		136,601
Investments held-to-maturity	2,395		—
Loans receivable, net of allowance of $13,836 and $13,218	1,138,243		1,108,462
Federal Home Loan Bank ("FHLB") stock, at cost	6,410		7,009
Accrued interest receivable	4,981		4,138
Deferred tax assets, net	2,007		1,501
Other real estate owned ("OREO")	454		454
Premises and equipment, net	22,222		22,466
Bank owned life insurance ("BOLI"), net	32,561		31,982
Prepaid expenses and other assets	1,513		2,216
Right of use asset (“ROU”)	2,972		2,209
Goodwill	889		889
Core deposit intangible	896		968
Total assets	$	1,418,355	$	1,341,885
Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing deposits	$	91,593	$	52,849
Interest-bearing deposits	1,034,575		980,685
Total deposits	1,126,168		1,033,534
FHLB advances	120,000		137,700
Advance payments from borrowers for taxes and insurance	2,475		2,921
Lease liability	3,070		2,279
Accrued interest payable	218		285
Other liabilities	12,448		8,847
Total liabilities	1,264,379		1,185,566
Commitments and contingencies
Stockholders' Equity
Preferred stock, $0.01 par value; authorized 10,000,000 shares; no shares    issued or outstanding	—		—
Common stock, $0.01 par value; authorized 90,000,000 shares; issued and    outstanding 10,048,961 shares at June 30, 2020, and 10,252,953    shares at December 31, 2019	100		103
Additional paid-in capital	85,119		87,370
Retained earnings	75,181		73,321
Accumulated other comprehensive loss, net of tax	(3,885)		(1,371)
Unearned Employee Stock Ownership Plan ("ESOP") shares	(2,539)		(3,104)
Total stockholders' equity	153,976		156,319
Total liabilities and stockholders' equity	$	1,418,355	$	1,341,885

See accompanying selected notes to consolidated financial statements.

3

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Income Statements

(Dollars in thousands, except per share data)

Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Interest income
Loans, including fees	$	13,183	$	13,606	$	26,657	$	26,887
Investments available-for-sale	796		1,109		1,715		2,268
Investments held-to-maturity	9		—		11		—
Interest-earning deposits	8		48		37		88
Dividends on FHLB stock	81		102		157		193
Total interest income	14,077		14,865		28,577		29,436
Interest expense
Deposits	3,666		4,330		8,032		8,152
Borrowings	344		829		814		1,726
Total interest expense	4,010		5,159		8,846		9,878
Net interest income	10,067		9,706		19,731		19,558
Provision (recapture of provision) for loan losses	300		(800)		600		(400)
Net interest income after provision (recapture of provision) for loan losses	9,767		10,506		19,131		19,958
Noninterest income
Net gain (loss) on sale of investments	69		—		69		(8)
BOLI income	254		189		509		458
Wealth management revenue	183		261		348		457
Deposit related fees	184		205		359		376
Loan related fees	97		209		489		272
Other	2		15		4		24
Total noninterest income	789		879		1,778		1,579
Noninterest expense
Salaries and employee benefits	4,801		4,734		10,013		9,734
Occupancy and equipment	1,031		898		2,103		1,764
Professional fees	455		326		885		822
Data processing	687		397		1,381		915
OREO related expenses, net	5		1		6		32
Regulatory assessments	127		136		271		273
Insurance and bond premiums	103		88		223		193
Marketing	29		76		93		162
Other general and administrative	706		627		1,236		1,097
Total noninterest expense	7,944		7,283		16,211		14,992
Income before federal income tax provision	2,612		4,102		4,698		6,545
Federal income tax provision	469		798		871		1,296
Net income	$	2,143	$	3,304	$	3,827	$	5,249
Basic earnings per common share	$	0.22	$	0.33	$	0.39	$	0.52
Diluted earnings per common share	$	0.22	$	0.33	$	0.39	$	0.52
Basic weighted average number of common shares outstanding	9,808,854		9,952,419		9,852,544		10,034,895
Diluted weighted average number of common shares outstanding	9,819,664		10,046,355		9,890,239		10,132,107

See accompanying selected notes to consolidated financial statements.

4

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive (Loss) Income

(In thousands)

(Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
Net income	$	2,143	$	3,304	$	3,827	$	5,249
Other comprehensive income (loss), before tax:
Unrealized holding gains on investments available-for-sale	1,821		1,423		1,494		2,399
Tax effect	(382)		(299)		(314)		(504)
Reclassification adjustment for net (gains) losses realized in income	(69)		—		(69)		8
Tax effect	14		—		14		(2)
Losses on cash flow hedges	(894)		(753)		(4,607)		(1,212)
Tax effect	188		158		968		255
Other comprehensive income (loss), net of tax	678		529		(2,514)		944
Total comprehensive income	$	2,821	$	3,833	$	1,313	$	6,193

See accompanying selected notes to consolidated financial statements.

5

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollars in thousands except share data)

(Unaudited)

	Three Months Ended June 30, 2019
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at March 31, 2019	10,457,625	$	104	$	89,800	$	67,568	$	(1,838)	$	(3,950)	$	151,684
Net income	—	—		—		3,304		—		—		3,304
Other comprehensive income, net of tax	—	—		—		—		529		—		529
Compensation related to stock options and restricted stock awards	—	—		107		—		—		—		107
Allocation of 28,213 ESOP shares	—	—		160		—		—		282		442
Repurchase and retirement of common stock	(82,300)	—		(1,342)		—		—		—		(1,342)
Cash dividend declared and paid ($0.09 per share)	—	—		—		(896)		—		—		(896)
Balances at June 30, 2019	10,375,325	$	104	$	88,725	$	69,976	$	(1,309)	$	(3,668)	$	153,828
	Six Months Ended June 30, 2019
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at December 31, 2018	10,710,656	$	107	$	93,773	$	66,343	$	(2,253)	$	(4,232)	$	153,738
Net income	—	—		—		5,249		—		—		5,249
Other comprehensive income, net of tax	—	—		—		—		944		—		944
Issuance of common stock - restricted stock awards, net	16,698	—		(93)		—		—		—		(93)
Compensation related to stock options and restricted stock awards	—	—		231		—		—		—		231
Allocation of 56,426 ESOP shares	—	—		323		—		—		564		887
Repurchase and retirement of common stock	(346,100)	(3)		(5,509)		—		—		—		(5,512)
Canceled common stock - restricted stock awards	(5,929)	—		—		—		—		—		—
Cash dividend declared and paid ($0.17 per share)	—	—		—		(1,703)		—		—		(1,703)
Beginning balance adjustment from adoption of Topic 842	—	—		—		87		—		—		87
Balances at June 30, 2019	10,375,325	$	104	$	88,725	$	69,976	$	(1,309)	$	(3,668)	$	153,828

6

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollars in thousands except share data)

(Unaudited)

	Three Months Ended June 30, 2020
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at March 31, 2020	10,184,411	$	102	$	86,357	$	74,017	$	(4,563)	$	(2,821)	$	153,092
Net income	—	—		—		2,143		—		—		2,143
Other comprehensive income, net of tax	—	—		—		—		678		—		678
Compensation related to stock options and restricted stock awards	—	—		63		—		—		—		63
Allocation of 28,214 ESOP shares	—	—		(21)		—		—		282		261
Repurchase and retirement of common stock	(135,450)	(2)		(1,280)		—		—		—		(1,282)
Cash dividend declared and paid ($0.10 per share)	—	—		—		(979)		—		—		(979)
Balances at June 30, 2020	10,048,961	$	100	$	85,119	$	75,181	$	(3,885)	$	(2,539)	$	153,976
	Six Months Ended June 30, 2020
	Shares	Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss, net of tax		Unearned ESOP Shares		Total Stockholders’ Equity
Balances at December 31, 2019	10,252,953	$	103	$	87,370	$	73,321	$	(1,371)	$	(3,104)	$	156,319
Net income	—	—		—		3,827		—		—		3,827
Other comprehensive loss, net of tax	—	—		—		—		(2,514)		—		(2,514)
Issuance of common stock - restricted stock awards, net	16,228	—		(73)		—		—		—		(73)
Compensation related to stock options and restricted stock awards	—	—		142		—		—		—		142
Allocation of 56,428 ESOP shares	—	—		78		—		—		565		643
Repurchase and retirement of common stock	(214,845)	(3)		(2,398)		—		—		—		(2,401)
Canceled common stock - restricted stock awards	(5,375)	—		—		—		—		—		—
Cash dividend declared and paid ($0.20 per share)	—	—		—		(1,967)		—		—		(1,967)
Balances at June 30, 2020	10,048,961	$	100	$	85,119	$	75,181	$	(3,885)	$	(2,539)	$	153,976

See accompanying selected notes to consolidated financial statements.

7

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2020		2019
Cash flows from operating activities:
Net income	$	3,827	$	5,249
Adjustments to reconcile net income to net cash provided by operating activities:
Provision (recapture of provision) for loan losses	600		(400)
OREO market value adjustments	—		29
Net amortization of premiums and discounts on investments	430		401
(Gain) loss on sale of investments available-for-sale	(69)		8
Depreciation of premises and equipment	1,099		862
Deferred federal income taxes	162		214
Allocation of ESOP shares	643		887
Stock compensation expense	142		231
BOLI income	(509)		(425)
Changes in operating assets and liabilities:
Decrease (increase) in prepaid expenses and other assets	349		(895)
Increase in ROU	(763)		(1,609)
Decrease in advance payments from borrowers for taxes and insurance	(446)		(89)
Increase in accrued interest receivable	(843)		(582)
Increase in lease liability	791		1,633
Decrease in accrued interest payable	(67)		(17)
Decrease in other liabilities	(580)		(1,571)
Net cash provided by operating activities	4,766		3,926
Cash flows from investing activities:
Proceeds from sales, calls and maturities of investments available-for-sale	9,567		2,995
Principal repayments on investments available-for-sale	6,152		2,604
Purchases of investments available-for-sale	(6,928)		(3,012)
Purchase of investments held-to-maturity	(2,395)		—
Net increase in loans receivable	(30,381)		(29,372)
Net sale of FHLB stock	599		1,609
Purchase of premises and equipment	(855)		(1,475)
Purchase of BOLI	(70)		(1,457)
Net cash used by investing activities	(24,311)		(28,108)
Cash flows from financing activities:
Net increase in deposits	92,634		86,678
Advances from the FHLB	218,000		162,500
Repayments of advances from the FHLB	(235,700)		(204,000)
Net share settlement of stock awards	(73)		(93)
Repurchase and retirement of common stock	(2,401)		(5,512)
Dividends paid	(1,967)		(1,703)
Net cash provided by financing activities	70,493		37,870

8

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

	Six Months Ended June 30,
	2020		2019
Net increase in cash and cash equivalents	50,948		13,688
Cash and cash equivalents at beginning of period	22,990		17,010
Cash and cash equivalents at end of period	$	73,938	$	30,698
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest paid	$	8,913	$	9,895
Federal income taxes paid	—		1,435
Noncash items:
Change in unrealized loss on investments available-for-sale	$	1,425	$	2,407
Change in unrealized loss on cash flow hedge	(4,607)		(1,212)
BOLI settlement receivable	—		277
Initial recognition of ROU	1,089		1,853
Initial recognition of lease liability	1,089		1,853

See accompanying selected notes to consolidated financial statements.

9

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Description of Business

First Financial Northwest, Inc. (“First Financial Northwest”), a Washington corporation, was formed on June 1, 2007 for the purpose of becoming the holding company for First Financial Northwest Bank (the “Bank”) in connection with the conversion from a mutual holding company structure to a stock holding company structure completed on October 9, 2007. First Financial Northwest’s business activities generally are limited to passive investment activities and oversight of its investment in First Financial Northwest Bank. Accordingly, the information presented in the consolidated financial statements and accompanying data, relates primarily to First Financial Northwest Bank. First Financial Northwest is a bank holding company, having converted from a savings and loan holding company on March 31, 2015, and as a bank holding company is subject to regulation by the Federal Reserve Bank of San Francisco. First Financial Northwest Bank is regulated by the Federal Deposit Insurance Corporation (“FDIC”) and the Washington State Department of Financial Institutions (“DFI”).

At June 30, 2020, First Financial Northwest Bank operated in thirteen locations in Washington with the headquarters and six retail branch locations in King County, five retail branch locations in Snohomish County and one retail branch in Pierce County. The Bank has received regulatory approval to open retail branches in Gig Harbor, in Pierce County, Washington, and in Issaquah, in King County, Washington. The Bank’s primary market area consists of King, Snohomish, Pierce and Kitsap counties, Washington.

The Bank is a portfolio lender, originating and purchasing one-to-four family residential, multifamily, commercial real estate, construction/land development, business, and consumer loans. Loans are primarily funded by deposits from the general public, supplemented by borrowings from the FHLB and deposits raised in the national brokered deposit market.

As used throughout this report, the terms “we,” “our,” “us,” or the “Company” refer to First Financial Northwest, Inc. and its consolidated subsidiary First Financial Northwest Bank, unless the context otherwise requires.

Note 2 - Basis of Presentation

        The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. These unaudited interim consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC (“2019 Form 10-K”). In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the unaudited interim consolidated financial statements in accordance with GAAP have been included. All significant intercompany balances and transactions between the Company and its subsidiaries have been eliminated in consolidation. Operating results for the six months ended June 30, 2020, are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. In preparing the unaudited consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the allowance for loan and lease losses (“ALLL”), the valuation of other real estate owned (“OREO”) and the underlying collateral of impaired loans, deferred tax assets, the right-of-use asset and lease liability on our operating leases, and the fair value of financial instruments.

The Company’s activities are considered to be a single industry segment for financial reporting purposes. The Company is engaged in the business of attracting deposits from the general public and originating and purchasing loans for its portfolio. Substantially all income is derived from a diverse base of commercial, multifamily, and residential real estate loans, consumer lending activities, and investments.

Certain amounts in the unaudited interim consolidated financial statements for prior periods have been reclassified to conform to the current unaudited financial statement presentation with no effect on consolidated net income or stockholders’ equity.

10

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 3 - Recently Issued Accounting Pronouncements

Recent Accounting Pronouncements Adopted in 2020

        In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this ASU remove certain disclosure requirements regarding transfers between Level 1 and Level 2 of the fair value hierarchy and changes in unrealized gains and losses for recurring Level 3 fair value measurements. In addition, the amendments modified and added certain disclosure requirements for Level 3 fair value measurements. The Company adopted this ASU as of January 1, 2020, with no material impact on the Company’s consolidated financial statements.

Recent Accounting Pronouncements

        ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) as amended by ASU 2018-19, ASU 2019-04 and ASU 2019-05, was originally issued in June 2016. This ASU replaces the existing incurred loss impairment methodology that recognizes credit losses when a probable loss has been incurred with new methodology where loss estimates are based upon lifetime expected credit losses. The amendments in this ASU require a financial asset that is measured at amortized cost to be presented at the net amount expected to be collected. The income statement would then reflect the measurement of credit losses for newly recognized financial assets as well as changes to the expected credit losses that have taken place during the reporting period. The measurement of expected credit losses will be based on historical information, current conditions, and reasonable and supportable forecasts that impact the collectability of the reported amount. Available-for-sale securities will bifurcate the fair value mark and establish an allowance for credit losses through the income statement for the credit portion of that mark. The interest portion will continue to be recognized through accumulated other comprehensive income or loss. The change in allowance recognized as a result of adoption will occur through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the ASU is adopted. This ASU is effective for smaller reporting companies, such as the Company, for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company is evaluating its current expected loss methodology on the loan and investment portfolios to identify the necessary modifications in accordance with this standard and expects a change in the processes and procedures to calculate the ALLL, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. A valuation adjustment to the ALLL or investment portfolio that is identified in this process will be reflected as a one-time adjustment in equity rather than earnings. ASU 2019-05 issued in April 2019 further provides that entities that have certain financial instruments measured at amortized cost that has credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of Topic 326. The fair value option applies to available-for-sale debt securities. This ASU is effective upon adoption of ASU 2016-13, and should be applied on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition as of the adoption date. The Company is in the process of compiling historical and industry data that will be used to calculate expected credit losses on the loan portfolio to ensure that it is fully compliant with the ASU at the adoption date and is evaluating the potential impact adoption of this ASU will have on its consolidated financial statements. The Company intends to adopt ASU 2016-13 in the first quarter of 2023, and as a result, the ALLL may increase. Until the evaluation is complete, however, the magnitude of the increase will not be known.

        In April 2019, FASB issued ASU 2019-05, Financial Instruments--Credit Losses (Topic 326), Targeted Transition Relief. The amendments in this ASU provide entities that have certain financial instruments measured at amortized cost that have credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of Topic 326. The fair value option applies to available-for-sale debt securities. This ASU is effective when ASU 2016-13 is adopted, and will be applied on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition as of the adoption date. Adoption of ASU 2019-05 is not expected to have a material impact on the Company’s consolidated financial statements.

        In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12). This ASU simplifies the accounting for income taxes by removing (i) the exception to the incremental approach for intra-period tax allocation when there is a loss from continuing operations and income or a gain from other items; (ii) the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, and (iii) the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. This ASU is effective for fiscal years, and interim periods within

11

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

those fiscal years, beginning after December 15, 2020. The Company does not expect the adoption of ASU 2019-12 to have a material impact on its consolidated financial statements.

        In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of reference Rate Reform on Financial Reporting. This ASU applies to contracts, hedging relationships and other transactions that reference the London Inter-bank Offered Rate (“LIBOR”) or other rate references expected to be discontinued because of reference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without requiring contract remeasurement or reassessment of a previous accounting determination. For a cash flow hedge, a change in the method used to assess hedge effectiveness will not result in de-designation of the hedging relationship if certain criteria are met. This ASU is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is party to cash flow hedge arrangements where the hedge effectiveness is based on LIBOR. The Company does not expect the adoption of ASU 2020-04 to have a material impact on its consolidated financial statements.

Note 4 - Investments

        Investments available-for-sale are summarized as follows at the dates indicated:

	June 30, 2020
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	13,241	$	527	$	(11)	$	13,757
Freddie Mac	4,151		203		—		4,354
Ginnie Mae	20,588		698		(10)		21,276
Other	11,007		128		(112)		11,023
Municipal bonds	13,503		684		(12)		14,175
U.S. Government agencies	43,652		64		(1,222)		42,494
Corporate bonds	22,001		114		(320)		21,795
Total	$	128,143	$	2,418	$	(1,687)	$	128,874

	December 31, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	15,605	$	128	$	(104)	$	15,629
Freddie Mac	4,196		96		—		4,292
Ginnie Mae	23,239		140		(329)		23,050
Other	11,407		66		(25)		11,448
Municipal bonds	10,675		272		(36)		10,911
U.S. Government agencies	46,672		13		(935)		45,750
Corporate bonds	25,500		372		(351)		25,521
Total	$	137,294	$	1,087	$	(1,780)	$	136,601

12

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

        The tables below summarize the aggregate fair value and gross unrealized loss by length of time those investment securities have been continuously in an unrealized loss position at the dates indicated:

	June 30, 2020
	Less Than 12 Months				12 Months or Longer				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	—	$	—	$	1,393	$	(11)	$	1,393	$	(11)
Freddie Mac	—		—		—		—		—		—
Ginnie Mae	1,429		(10)		—		—		1,429		(10)
Other	—		—		5,895		(112)		5,895		(112)
Municipal bonds	1,628		(12)		—		—		1,628		(12)
U.S. Government agencies	7,049		(235)		32,087		(987)		39,136		(1,222)
Corporate bonds	5,942		(66)		3,746		(254)		9,688		(320)
Total	$	16,048	$	(323)	$	43,121	$	(1,364)	$	59,169	$	(1,687)

	December 31, 2019
	Less Than 12 Months				12 Months or Longer				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
	(In thousands)
Mortgage-backed investments:
Fannie Mae	$	8,340	$	(104)	$	—	$	—	$	8,340	$	(104)
Freddie Mac	—		—		—		—		—		—
Ginnie Mae	156		—		12,921		(329)		13,077		(329)
Other	2,843		(7)		6,000		(18)		8,843		(25)
Municipal bonds	3,257		(36)		—		—		3,257		(36)
U.S. Government agencies	12,266		(201)		31,490		(734)		43,756		(935)
Corporate bonds	1,996		(12)		7,161		(339)		9,157		(351)
Total	$	28,858	$	(360)	$	57,572	$	(1,420)	$	86,430	$	(1,780)

On a quarterly basis, management makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment, recent events specific to the issuer or industry, and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be an other-than-temporary impairment (“OTTI”) are written down to fair value. If the Company intends to sell a debt security, or it is likely that the Company will be required to sell the debt security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the debt security and it is not likely that it will be required to sell the debt security but does not expect to recover the entire amortized cost basis of the debt security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a debt security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the debt security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. The Company had 26 securities and 37 securities in an unrealized loss position, respectively, with 16 and 18 of these securities in an unrealized loss position for 12 months or more, at June 30, 2020, and December 31, 2019, respectively. Management does not believe that any individual unrealized loss as of June 30, 2020, or December 31, 2019, represented OTTI. The decline in fair market value of these securities was generally due to changes in interest rates and changes in market-desired spreads subsequent

13

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

to their purchase. Management also reviewed the financial condition of the entities issuing municipal or corporate bonds at June 30, 2020, and December 31, 2019, and determined that an OTTI charge was not warranted.

        The amortized cost and estimated fair value of investments available-for-sale at June 30, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments not due at a single maturity date, primarily mortgage-backed investments, are shown separately.

	June 30, 2020
	Amortized Cost		Fair Value
	(In thousands)
Due within one year	$	498	$	499
Due after one year through five years	6,538		6,561
Due after five years through ten years	18,392		18,242
Due after ten years	53,728		53,162
	79,156		78,464
Mortgage-backed investments	48,987		50,410
Total	$	128,143	$	128,874

Under Washington state law, in order to participate in the public funds program the Company is required to pledge eligible securities as collateral in an amount equal to 50% of the public deposits held less the FDIC insured amount. Investment securities with market values of $19.5 million and $19.0 million were pledged as collateral for public deposits at June 30, 2020, and December 31, 2019, respectively, both of which exceeded the collateral requirements established by the Washington Public Deposit Protection Commission.

        For the three and six months ended June 30, 2020, there were $9.6 million in sales or maturities on investment securities generating a net gain of $69,000. For the three months ended June 30, 2019, there were no sales of investment securities. For the six months ended June 30, 2019, the Bank had calls and sales on investment securities of $3.0 million generating a net loss of $8,000.

        In January 2020, the Bank purchased three annuity contracts, totaling $2.4 million, to be held long-term to satisfy the benefit obligation associated with certain supplemental executive retirement plan agreements. The annuities are reported at amortized cost as investments held-to-maturity on the Company’s Consolidated Balance Sheet. The amortized cost is considered the fair value of the investment.

14

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 5 - Loans Receivable

Loans receivable are disclosed net of loans in process (“LIP”) and are summarized as follows at the dates indicated: 

	June 30, 2020		December 31, 2019
	(In thousands)
One-to-four family residential:
Permanent owner occupied	$	208,484	$	210,898
Permanent non-owner occupied	173,729		161,630
	382,213		372,528
Multifamily	159,371		172,915
Commercial real estate	390,750		395,152
Construction/land:
One-to-four family residential	45,128		44,491
Multifamily	40,120		40,954
Commercial	6,134		19,550
Land	5,115		8,670
	96,497		113,665
Business	86,070		37,779
Consumer	39,231		30,199
Total loans	1,154,132		1,122,238
Less:
Deferred loan fees, net	2,053		558
ALLL	13,836		13,218
Loans receivable, net	$	1,138,243	$	1,108,462

        At June 30, 2020, loans totaling $496.3 million were pledged to secure borrowings from the FHLB compared to $506.7 million at December 31, 2019. In addition, loans totaling $133.0 million and $130.3 million were pledged to the Federal Reserve Bank of San Francisco to secure a line of credit at June 30, 2020 and December 31, 2019, respectively.

Credit Quality Indicators. The Company assigns a risk rating to all credit exposures based on a risk rating system designed to define the basic characteristics and identified risk elements of each credit extension. The Company utilizes a nine point risk rating system. A description of the general characteristics of the risk grades is as follows:

•Grades 1 through 5: These grades are considered to be “pass” credits. These include assets where there is limited credit risk, such as cash secured loans with funds on deposit with the Bank. Pass credits also include credits that are on the Company’s watch list, where the borrower exhibits potential weaknesses, which may, if not checked or corrected, negatively affect the borrower’s financial capacity and threaten their ability to fulfill debt obligations in the future.

•Grade 6: These credits, classified as “special mention”, possess weaknesses that deserve management’s close attention. Special mention assets do not expose the Company to sufficient risk to warrant adverse classification in the substandard, doubtful or loss categories. If left uncorrected, these potential weaknesses may result in deterioration in the Company’s credit position at a future date.

15

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

•Grade 7: These credits, classified as “substandard”, present a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. These credits have well defined weaknesses which jeopardize the orderly liquidation of the debt and are inadequately protected by the current net worth and payment capacity of the borrower or of any collateral pledged.

•Grade 8: These credits are classified as “doubtful” and possess well defined weaknesses which make the full collection or liquidation of the loan highly questionable and improbable. This classification is used where significant risk exposures are perceived but the exact amount of the loss cannot yet be determined due to pending events.

•Grade 9: Assets classified as “loss” are considered uncollectible and cannot be justified as a viable asset for the Company. There is little or no prospect of near term recovery and no realistic strengthening action of significance is pending.

        As of June 30, 2020, and December 31, 2019, the Company had no loans rated as doubtful or loss. The following tables represent a summary of loans at June 30, 2020, and December 31, 2019 by type and risk category:

	June 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/  Land		Business		Consumer		Total
	(In thousands)
Risk Rating:
Pass	$	381,067	$	157,267	$	374,614	$	96,497	$	86,070	$	39,231	$	1,134,746
Special mention	527		—		16,136		—		—		—		16,663
Substandard	619		2,104		—		—		—		—		2,723
Total loans	$	382,213	$	159,371	$	390,750	$	96,497	$	86,070	$	39,231	$	1,154,132

	December 31, 2019
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Risk Rating:
Pass	$	371,363	$	170,810	$	394,627	$	101,141	$	37,779	$	30,199	$	1,105,919
Special mention	536		2,105		525		12,524		—		—		15,690
Substandard	629		—		—		—		—		—		629
Total loans	$	372,528	$	172,915	$	395,152	$	113,665	$	37,779	$	30,199	$	1,122,238

ALLL. When the Company classifies problem assets as either substandard or doubtful, pursuant to Federal regulations, or identifies a loan where it is uncertain if the Bank will be able to collect all amounts due according to the contractual terms of the loan, it may establish a specific reserve in an amount deemed prudent to address the risk specifically. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to the particular problem assets. When an insured institution classifies problem assets as a loss, pursuant to Federal regulations, it is required to charge-off such assets in the period in which they are deemed uncollectible. The determination as to the classification of the Company’s assets and the amount of valuation allowances is subject to review by bank regulators, who can require the establishment of additional allowances for loan losses.

At June 30, 2020, total loans receivable included $51.7 million of loans originated under the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). PPP loans are 100% guaranteed by the SBA. Although these loans were included in the population of loans collectively evaluated for impairment, no general reserve was allocated to them as these loans are 100% guaranteed by the SBA.

16

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loan grades are used by the Company to identify and track potential problem loans which do not rise to the levels described for substandard, doubtful, or loss. The grades for watch and special mention are assigned to loans which have been criticized based upon known characteristics such as periodic payment delinquency, failure to comply with contractual terms of the loan or stale financial information from the borrower and/or guarantors. Loans identified as criticized (watch and special mention) or classified (substandard, doubtful or loss) are subject to problem loan reporting every three months.

The following tables summarize changes in the ALLL and loan portfolio by loan type and impairment method at the dates and for the periods shown: 

	At or For the Three Months Ended June 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial  Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,055	$	1,658	$	4,693	$	2,143	$	1,074	$	907	$	13,530
Recoveries	6		—		—		—		—		—		6
Provision (Recapture)	73		(99)		156		114		(9)		65		300
Ending balance	$	3,134	$	1,559	$	4,849	$	2,257	$	1,065	$	972	$	13,836
	At or For the Six Months Ended June 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial  Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,034	$	1,607	$	4,559	$	2,222	$	1,140	$	656	$	13,218
Recoveries	18		—		—		—		—		—		18
Provision (Recapture)	82		(48)		290		35		(75)		316		600
Ending balance	$	3,134	$	1,559	$	4,849	$	2,257	$	1,065	$	972	$	13,836
ALLL by category:
General reserve	$	3,119	$	1,559	$	4,849	$	2,257	$	1,065	$	972	$	13,821
Specific reserve	15		—		—		—		—		—		15
Loans:
Total loans	$	382,213	$	159,371	$	390,750	$	96,497	$	86,070	$	39,231	$	1,154,132
Loans collectively evaluated for impairment (1)	379,130		157,267		373,877		96,497		86,070		39,231		1,132,072
Loans individually evaluated for impairment (2)	3,083		2,104		16,873		—		—		—		22,060

____________ 

⁽¹⁾ Loans collectively evaluated for general reserves.

⁽²⁾ Loans individually evaluated for specific reserves.

17

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	At or For the Three Months Ended June 30, 2019
	One-to-Four Family Residential		Multifamily		Commercial  Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,032	$	1,579	$	4,809	$	3,132	$	1,030	$	226	$	13,808
Recoveries	4		45		—		—		—		—		49
Provision (recapture)	49		19		(202)		(861)		90		105		(800)
Ending balance	$	3,085	$	1,643	$	4,607	$	2,271	$	1,120	$	331	$	13,057
	At or For the Six Months Ended June 30, 2019
	One-to-Four Family Residential		Multifamily		Commercial  Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
ALLL:
Beginning balance	$	3,387	$	1,680	$	4,777	$	2,331	$	936	$	236	$	13,347
Recoveries	28		45		—		—		—		37		110
(Recapture) provision	(330)		(82)		(170)		(60)		184		58		(400)
Ending balance	$	3,085	$	1,643	$	4,607	$	2,271	$	1,120	$	331	$	13,057
ALLL by category:
General reserve	$	3,047	$	1,643	$	4,607	$	2,271	$	1,120	$	331	$	13,019
Specific reserve	38		—		—		—		—		—		38
Loans:
Total loans	$	361,256	$	161,460	$	384,202	$	105,134	$	36,358	$	17,891	$	1,066,301
Loans collectively evaluated for impairment (1)	356,558		161,460		382,061		93,551		36,358		17,848		1,047,836
Loans individually evaluated for impairment (2)	4,698		—		2,141		11,583		—		43		18,465

_____________ 

⁽¹⁾ Loans collectively evaluated for general reserves.

⁽²⁾ Loans individually evaluated for specific reserves.

18

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Past Due Loans. Loans are considered past due if a scheduled principal or interest payment is due and unpaid for 30 days or more. At June 30, 2020, past due loans were 0.18% of total loans receivable. In comparison, past due loans were 0.19% of total loans receivable at December 31, 2019. The following tables represent a summary of the aging of loans by type at the dates indicated:

	Loans Past Due as of June 30, 2020
	30-59 Days		60-89 Days		90 Days and Greater		Total Past Due		Current		Total (1)
	(In thousands)
Real estate:
One-to-four family residential:
Owner occupied	$	—	$	—	$	—	$	—	$	208,484	$	208,484
Non-owner occupied	—		—		—		—		173,729		173,729
Multifamily	—		—		2,104		2,104		157,267		159,371
Commercial real estate	—		—		—		—		390,750		390,750
Construction/land	—		—		—		—		96,497		96,497
Total real estate	—		—		2,104		2,104		1,026,727		1,028,831
Business	—		—		—		—		86,070		86,070
Consumer	9		—		—		9		39,222		39,231
Total loans	$	9	$	—	$	2,104	$	2,113	$	1,152,019	$	1,154,132

 ________________ 

⁽¹⁾ There were no loans 90 days and greater past due and still accruing interest at June 30, 2020.

	Loans Past Due as of December 31, 2019
	30-59 Days		60-89 Days		90 Days and Greater		Total Past Due		Current		Total (1)
	(In thousands)
Real estate:
One-to-four family residential:
Owner occupied	$	79	$	—	$	—	$	79	$	210,819	$	210,898
Non-owner occupied	—		—		—		—		161,630		161,630
Multifamily	2,105		—		—		2,105		170,810		172,915
Commercial real estate	—		—		—		—		395,152		395,152
Construction/land	—		—		—		—		113,665		113,665
Total real estate	2,184		—		—		2,184		1,052,076		1,054,260
Business	—		—		—		—		37,779		37,779
Consumer	—		—		—		—		30,199		30,199
Total loans	$	2,184	$	—	$	—	$	2,184	$	1,120,054	$	1,122,238

_________________ 

⁽¹⁾ There were no loans 90 days and greater past due and still accruing interest at December 31, 2019.

Nonperforming Loans. When a loan becomes 90 days past due, the Bank generally places the loan on nonaccrual status. Loans may be placed on nonaccrual status prior to being 90 days past due if there is an identified problem that indicates the borrower is unable to meet their scheduled payment obligations. The following table is a summary of nonaccrual loans by loan type at the dates indicated:

19

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	June 30, 2020		December 31, 2019
	(In thousands)
One-to-four family residential	$	87	$	95
Multifamily	2,104		—
Total nonaccrual loans	$	2,191	$	95

During the three and six months ended June 30, 2020, interest income that would have been recognized had these nonaccrual loans been performing in accordance with their original terms was $26,000 and $36,000. For the three and six months ended June 30, 2019, foregone interest on nonaccrual loans was $2,000 and $9,000, respectively.

The following tables summarize the loan portfolio by type and payment status at the dates indicated:

	June 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Performing (1)	$	382,126	$	157,267	$	390,750	$	96,497	$	86,070	$	39,231	$	1,151,941
Nonperforming (2)	87		2,104		—		—		—		—		2,191
Total loans	$	382,213	$	159,371	$	390,750	$	96,497	$	86,070	$	39,231	$	1,154,132

_____________

⁽¹⁾ There were $208.4 million of owner-occupied one-to-four family residential loans and $173.7 million of non-owner occupied one-to-four family residential loans classified as performing.

⁽²⁾ The $87,000 one-to-four family residential loan classified as nonperforming is owner-occupied.

	December 31, 2019
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/ Land		Business		Consumer		Total
	(In thousands)
Performing (1)	$	372,433	$	172,915	$	395,152	$	113,665	$	37,779	$	30,199	$	1,122,143
Nonperforming (2)	95		—		—		—		—		—		95
Total loans	$	372,528	$	172,915	$	395,152	$	113,665	$	37,779	$	30,199	$	1,122,238

_____________

⁽¹⁾ There were $210.8 million of owner-occupied one-to-four family residential loans and $161.6 million of non-owner occupied one-to-four family residential loans classified as performing.

⁽²⁾ The $95,000 one-to-four family residential loan classified as nonperforming is owner-occupied.

Impaired Loans. A loan is considered impaired when we have determined that we may be unable to collect payments of principal or interest when due under the terms of the original loan document or the borrower failing to comply with contractual terms of the loan. At June 30, 2020, there were no commitments to advance funds related to impaired loans. At December 31, 2019, there was $3.1 million committed to be advanced on an impaired $12.5 million construction/land loan. During the six months ended June 30, 2020, this construction/land loan became fully funded and was reclassified as a permanent commercial real estate loan with a $15.7 million principal balance at June 30, 2020. The Bank authorized completion of the loan funding because it determined that it was in the Bank’s best interest to finalize the construction project. At June 30, 2020, the loan is well collateralized and the Bank currently does not expect to incur a loss.

20

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables present a summary of loans individually evaluated for impairment by loan type at the dates indicated:

	June 30, 2020
	Recorded Investment (1)		Unpaid Principal Balance (2)		Related Allowance
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	425	$	572	$	—
Non-owner occupied	1,190		1,191		—
Multifamily	2,104		2,104		—
Commercial real estate	16,873		16,873		—
Total	20,592		20,740		—
Loans with an allowance:
One-to-four family residential:
Owner occupied	502		549		9
Non-owner occupied	966		966		6
Total	1,468		1,515		15
Total impaired loans:
One-to-four family residential:
Owner occupied	927		1,121		9
Non-owner occupied	2,156		2,157		6
Multifamily	2,104		2,104		—
Commercial real estate	16,873		16,873		—
Total	$	22,060	$	22,255	$	15

_________________ 

⁽¹⁾ Represents the loan balance less charge-offs.

⁽²⁾ Contractual loan principal balance.

21

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	December 31, 2019
	Recorded Investment (1)		Unpaid Principal Balance (2)		Related Allowance
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	437	$	582	$	—
Non-owner occupied	1,486		1,486		—
Multifamily	2,105		2,105		—
Commercial real estate	1,266		1,266		—
Construction/land	12,524		15,650		—
Total	17,818		21,089		—
Loans with an allowance:
One-to-four family residential:
Owner occupied	505		552		13
Non-owner occupied	1,647		1,647		18
Total	2,152		2,199		31
Total impaired loans:
One-to-four family residential:
Owner occupied	942		1,134		13
Non-owner occupied	3,133		3,133		18
Multifamily	2,105		2,105		—
Commercial real estate	1,266		1,266		—
Construction/land	12,524		15,650		—
Total	$	19,970	$	23,288	$	31

_________________ 

⁽¹⁾ Represents the loan balance less charge-offs.

⁽²⁾ Contractual loan principal balance.

22

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

        The following table presents the average recorded investment in loans individually evaluated for impairment and the interest income recognized for the three and six months ended June 30, 2020 and 2019:

	Three Months Ended June 30, 2020				Six Months Ended June 30, 2020
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	427	$	8	$	430	$	22
Non-owner occupied	1,240		19		1,322		45
Multifamily	2,104		46		2,104		140
Commercial real estate	9,065		203		6,465		450
Construction/land	7,825		—		9,391		—
Total	20,661		276		19,712		657
Loans with an allowance:
One-to-four family residential:
Owner occupied	503		7		503		18
Non-owner occupied	1,302		15		1,417		35
Total	1,805		22		1,920		53
Total impaired loans:
One-to-four family residential:
Owner occupied	930		15		933		40
Non-owner occupied	2,542		34		2,739		80
Multifamily	2,104		46		2,104		140
Commercial real estate	9,065		203		6,465		450
Construction/land	7,825		—		9,391		—
Total	$	22,466	$	298	$	21,632	$	710

23

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	Three Months Ended June 30, 2019				Six Months Ended June 30, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
Loans with no related allowance:
One-to-four family residential:
Owner occupied	$	843	$	15	$	998	$	30
Non-owner occupied	1,863		26		2,034		52
Commercial real estate	2,149		38		2,265		76
Construction/land	5,792		228		3,861		368
Consumer	44		1		58		2
Total	10,691		308		9,216		528
Loans with an allowance:
One-to-four family residential:
Owner occupied	510		9		511		17
Non-owner occupied	2,015		22		2,385		45
Commercial real estate	—		—		80		—
Total	2,525		31		2,976		62
Total impaired loans:
One-to-four family residential:
Owner occupied	1,353		24		1,509		47
Non-owner occupied	3,878		48		4,419		97
Commercial real estate	2,149		38		2,345		76
Construction/land	5,792		228		3,861		368
Consumer	44		1		58		2
Total	$	13,216	$	339	$	12,192	$	590

Troubled Debt Restructurings. Certain loan modifications are accounted for as troubled debt restructured loans (“TDRs”). At June 30, 2020, the TDR portfolio totaled $4.3 million. At December 31, 2019, the TDR portfolio totaled $5.2 million. At both dates, all TDRs were performing according to their modified repayment terms.

At June 30, 2020, the Company had no commitments to extend additional credit to borrowers whose loan terms have been modified in TDRs. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment as part of the calculation of the ALLL. No loans accounted for as TDRs were charged-off to the ALLL for the three and six months ended June 30, 2020 and 2019.

The Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act"), signed into law on March 27, 2020, provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. To qualify as an eligible loan under the CARES Act, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency by the President or (B) December 31, 2020. At June 30, 2020, total loans receivable included $132.1 million of loans that had been granted short term deferrals under the CARES Act. For additional information on these deferrals, see “Item 1. Management’s Discussion and Analysis of Financial Condition and Results of Operations, COVID - 19 Related Information.”

24

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

There were no TDR modifications during the three and six months ended June 30, 2020, or for the three months ended June 30, 2019. The following table presents TDR modifications for the six months ended June 30, 2019, and their recorded investment prior to and after the modification:

	Six Months Ended June 30, 2019
	Number of Loans	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(Dollars in thousands)
One-to-four family residential
Principal and interest with interest rate concession and advancement of maturity date	6	$	824	$	824
Advancement of maturity date	3	694		694
Total	9	$	1,518	$	1,518

TDRs that default after they have been modified are typically evaluated individually on a collateral basis. Any additional impairment is charged to the ALLL. For the three and six months ended June 30, 2020, and June 30, 2019, no loans that had been modified in the previous 12 months defaulted.  

Note 6 - Other Real Estate Owned

OREO includes properties acquired by the Company through foreclosure and deed in lieu of foreclosure. The following table is a summary of OREO activity during the periods shown: 

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
	(In thousands)
Balance at beginning of period	$	454	$	454	$	454	$	483
Market value adjustments	—		—		—		(29)
Balance at end of period	$	454	$	454	$	454	$	454

For the three and six months ended June 30, 2020, there were no OREO properties sold and no market value adjustments taken on the properties in OREO. For the three and six months ended June 30, 2019, there were no OREO properties sold and $29,000 in market value adjustments on OREO properties. OREO at June 30, 2020, consisted of $454,000 in commercial real estate properties. At June 30, 2020, there was a $2.1 million multifamily loan and no one-to-four family residential loans for which formal foreclosure proceedings were in process.

25

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7 - Fair Value

The Company determines the fair values of its financial instruments based on the fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair values. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect its estimate for market assumptions.

Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions that market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from an independent source. Unobservable inputs are assumptions based on the Company’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date.

        All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy:

•Level 1 - Quoted prices for identical instruments in active markets.

•Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable.

•Level 3 - Instruments whose significant value drivers are unobservable.

The Company used the following methods to measure fair value on a recurring or nonrecurring basis:

•Investments available-for-sale: The fair value of all investments, excluding FHLB stock, was based upon quoted market prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable.

•Impaired loans: The fair value of impaired loans is measured using the present value of expected future cash flows discounted at the loan’s effective interest rate. When the sole source of repayment of the loan is the operation or liquidation of the collateral, the fair value is determined using the observable market price less certain completion costs and completion costs.

•OREO: The fair value of OREO properties is measured at the lower of the carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. in cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

•Derivatives: The fair value of derivatives is based on dealer quotes, pricing models, discounted cash flow methodologies or similar techniques for which the determination of fair value may require significant management judgment or estimation.

26

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The tables below present the balances of assets and liabilities measured at fair value on a recurring basis (there were no transfers between Level 1, Level 2 and Level 3 recurring measurements) at June 30, 2020 and December 31, 2019:

	Fair Value Measurements at June 30, 2020
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Assets:
Investments available-for-sale:
Mortgage-backed investments:
Fannie Mae	$	13,757	$	—	$	13,757	$	—
Freddie Mac	4,354		—		4,354		—
Ginnie Mae	21,276		—		21,276		—
Other	11,023		—		11,023		—
Municipal bonds	14,175		—		14,175		—
U.S. Government agencies	42,494		—		42,494		—
Corporate bonds	21,795		—		21,795		—
Total available-for-sale investments	128,874		—		128,874		—
Liabilities:
Derivative fair value liability	4,181		—		4,181		—

	Fair Value Measurements at December 31, 2019
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Investments available-for-sale:
Mortgage-backed investments:
Fannie Mae	$	15,629	$	—	$	15,629	$	—
Freddie Mac	4,292		—		4,292		—
Ginnie Mae	23,050		—		23,050		—
Other	11,448		—		11,448		—
Municipal bonds	10,911		—		10,911		—
U.S. Government agencies	45,750		—		45,750		—
Corporate bonds	25,521		—		25,521		—
Total available-for-sale investments	136,601		—		136,601		—
Derivative fair value asset	426		—		426		—
Total	$	137,027	$	—	$	137,027	$	—

        The estimated fair value of Level 2 investments is based on quoted prices for similar investments in active markets, identical or similar investments in markets that are not active and model-derived valuations whose inputs are observable. 

27

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The tables below present the balances of assets measured at fair value on a nonrecurring basis at June 30, 2020, and December 31, 2019: 

	Fair Value Measurements at June 30, 2020
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Impaired loans (included in loans receivable, net) (1)	$	22,045	$	—	$	—	$	22,045
OREO	454		—		—		454
Total	$	22,499	$	—	$	—	$	22,499

_____________

⁽¹⁾ Total fair value of impaired loans is net of $15,000 of specific reserves on performing TDRs.

	Fair Value Measurements at December 31, 2019
	Fair Value Measurements		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(In thousands)
Impaired loans (included in loans receivable, net) (1)	$	19,939	$	—	$	—	$	19,939
OREO	454		—		—		454
Total	$	20,393	$	—	$	—	$	20,393

_____________

⁽¹⁾ Total fair value of impaired loans is net of $31,000 of specific reserves on performing TDRs.

The fair value of impaired loans reflects the exit price and is calculated using the collateral value method or on a discounted cash flow basis. Inputs used in the collateral value method include appraised values, less estimated costs to sell. Some of these inputs may not be observable in the marketplace. Appraised values may be discounted based on management’s knowledge of the marketplace, subsequent changes in market conditions, or management’s knowledge of the borrower.

The following tables present quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at June 30, 2020 and December 31, 2019:

	June 30, 2020
	Fair Value		Valuation Technique	Unobservable Input(s)	Range (Weighted Average)
	(Dollars in thousands)
Impaired Loans	$	22,045	Market approach	Appraised value discounted by market or borrower conditions	0.0% (0.0%)
OREO	$	454	Market approach	Appraised value less selling costs	0.0% (0.0%)

28

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	December 31, 2019
	Fair Value		Valuation Technique	Unobservable Input(s)	Range (Weighted Average)
	(Dollars in thousands)
Impaired Loans	$	19,939	Market approach	Appraised value discounted by market or borrower conditions	0.0% (0.0%)
OREO	$	454	Market approach	Appraised value less selling costs	0.0%  (0.0%)

        The carrying amounts and estimated fair values of financial instruments were as follows at the dates indicated: 

	June 30, 2020
			Estimated		Fair Value Measurements Using:
	Carrying Value		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash on hand and in banks	$	7,688	$	7,688	$	7,688	$	—	$	—
Interest-earning deposits with banks	66,250		66,250		66,250		—		—
Investments available-for-sale	128,874		128,874		—		128,874		—
Investments held-to-maturity	2,395		2,395		—		2,395		—
Loans receivable, net	1,138,243		1,127,096		—		—		1,127,096
FHLB stock	6,410		6,410		—		6,410		—
Accrued interest receivable	4,981		4,981		—		4,981		—
Financial Liabilities:
Deposits	643,233		643,233		643,233		—		—
Certificates of deposit, retail	450,487		462,258		—		462,258		—
Certificates of deposit, brokered	32,448		33,023		—		33,023		—
Advances from the FHLB	120,000		124,271		—		124,271		—
Accrued interest payable	218		218		—		218		—
Derivative fair value liability	4,181		4,181		—		4,181		—

29

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	December 31, 2019
			Estimated		Fair Value Measurements Using:
	Carrying Value		Fair Value		Level 1		Level 2		Level 3
	(In thousands)
Financial Assets:
Cash on hand and in banks	$	10,094	$	10,094	$	10,094	$	—	$	—
Interest-earning deposits with banks	12,896		12,896		12,896		—		—
Investments available-for-sale	136,601		136,601		—		136,601		—
Loans receivable, net	1,108,462		1,096,499		—		—		1,096,499
FHLB stock	7,009		7,009		—		7,009		—
Accrued interest receivable	4,138		4,138		—		4,138		—
Derivative fair value asset	426		426		—		426		—
Financial Liabilities:
Deposits	513,959		513,959		513,959		—		—
Certificates of deposit, retail	425,103		430,418		—		430,418		—
Certificates of deposit, brokered	94,472		94,556		—		94,556		—
Advances from the FHLB	137,700		137,706		—		137,706		—
Accrued interest payable	285		285		—		285		—

Note 8 - Leases

        The Company adopted ASU 2016-02 and ASU 2018-11 using the modified retrospective approach with an effective date of January 1, 2019, and recognized on the consolidated balance sheets a ROU included in prepaid expenses and other assets and lease liabilities included in other liabilities. At June 30, 2020, the Company had 12 operating leases for retail branch locations. The remaining lease terms range from two months to 5.2 years, with most leases carrying optional extensions of 3-5 years. The Company will include optional lease term extensions in the ROU and lease liabilities when management believes it is reasonably certain that the term extension will be exercised, and will be determined based on indicators that the Company would have an economic incentive to extend the lease. The Company has elected to not apply ASU 2016-02 to short term leases, which are those that have a term of one year or less. To calculate the present value of lease payments not yet paid, the Company uses the incremental borrowing rate, which is equal to the FHLB advance rate for the remaining term of the lease that was in place at January 1, 2019, or for leases added after that date, at the time of lease inception.

        The minimum monthly lease payments are generally based on square footage of the leased premises, with escalating minimum rent over the lease term. At June 30, 2020, the Company was committed to paying $57,000 per month in minimum monthly lease payments. The minimum monthly lease payment over the initial lease term, including any free rent period, was used to calculate the ROU and lease liability. The Company’s current leases do not include any non-lease components.

        Total lease expense included in the Company’s Consolidated Income Statements for the three and six months ended June 30, 2020 was $218,000 and $443,000, respectively, and for the three and six months ended June 30, 2019 was $169,000 and $344,000, respectively. Lease expense includes the amortized lease expense under ASU 2016-02 combined with variable lease expenses for maintenance or other expenses as defined in the individual lease agreements. At June 30, 2020, the ROU had a balance of $2.97 million and the lease liability had a balance of $3.07 million on the Company’s consolidated balance sheet and is amortizing over a weighted-average remaining term of 7.4 years. The weighted-average discount rate used to calculate the present value of future minimum lease payments was 2.56% at June 30, 2020.

30

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table provides a reconciliation between the undiscounted minimum lease payments at June 30, 2020 and the discounted lease liability at that date:

	June 30, 2020
	(in thousands)
Due through one year	$	618
Due after one year through two years	503
Due after two years through three years	467
Due after three years through four years	392
Due after four years through five years	297
Due after five years	1,089
Total minimum lease payments	3,366
Less: present value discount	(296)
Lease liability	$	3,070

        The Company has secured a lease for a new retail branch in Gig Harbor, Washington that commenced in June 2020 with expectation to open late in 2020. The initial lease term is 63 months and includes three extension options of five years each. The minimum rent due is $5,300 with a 3% annual increase. The Company is finalizing a lease for a new retail branch in Issaquah, Washington, which is expected to commence early in 2021.

Note 9 - Derivatives

        The Company uses derivative financial instruments, in particular, interest rate swaps, which qualify as cash flow hedges, to manage the risk of changes in future cash flows due to interest rate fluctuations. At June 30, 2020, the Company held six interest rate swap agreements with initial terms of four to eight years, and total notional amount of $120.0 million. In addition, at that date, the Company held two forward-starting interest rate swap agreements with terms of seven and eight years and a total notional amount of $25.0 million. Under the current agreements, the Company pays a weighted-average fixed interest rate of 1.22% monthly and in exchange receives variable rate amounts from the interest rate swap counter party based on 1-month or 3-month LIBOR, based on the swap agreement’s stated rate reset date. On the forward-starting agreements, the Company will pay a weighted average fixed rate of 0.80% and in exchange receives variable rate amounts from the interest rate swap counter party based on 3-month LIBOR. Concurrent with each interest rate swap start dates, the Company secured fixed rate FHLB advances, for the notional amount of the swap, that reset at 1-month or 3-month cycles based on the rate reset dates of the interest rate swap agreement. The Company pays or receives the net interest to the counter party amount monthly or quarterly, based on the respective hedge agreement, and includes this amount as part of its interest expense on the Consolidated Income Statement.

        Quarterly, the effectiveness evaluation is based upon the fluctuation of the interest the Company pays to the FHLB for the hedge instruments as compared to the one-month or three-month LIBOR interest received from the counterparty. At June 30, 2020, the net fair value loss of the cash flow hedges of $4.2 million was reported with other liabilities. The tax effected amount of $3.3 million was included in Accumulated Other Comprehensive Loss. There were no amounts recorded in the Consolidated Income Statements for the quarters ended June 30, 2020 or 2019, related to ineffectiveness.

        Fair value for these derivative instruments, which generally changes as a result of changes in the level of market interest rates, is estimated based on dealer quotes and secondary market sources.

31

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the fair value of these derivative instruments as of June 30, 2020 and December 31, 2019:

	Balance Sheet Location	Fair Value at June 30, 2020		Fair Value at December 31, 2019
	(In thousands)
Interest rate swaps on FHLB debt designated as a cash flow hedge	(Other liabilities) Other assets	$	(4,181)	$	426
Total derivatives		$	(4,181)	$	426

        The following table presents the net unrealized gains and losses from these derivative instruments included on the Consolidated Statements of Comprehensive Income at the dates indicated:

	Amount Recognized in OCI for the three months ended June 30, 2020		Amount Recognized in OCI for the three months ended June 30, 2019		Amount Recognized in OCI for the six months ended June 30, 2020		Amount Recognized in OCI for the six months ended June 30, 2019
	(In thousands)
Interest rate swaps on FHLB debt designated as a cash flow hedge	$	(706)	$	(595)	$	(3,639)	$	664

Note 10 - Stock-Based Compensation

In June 2016, First Financial Northwest’s shareholders approved the First Financial Northwest, Inc. 2016 Equity Incentive Plan (“2016 Plan”). This plan provides for the granting of incentive stock options (“ISO”), non-qualified stock options (“NQSO”), restricted stock and restricted stock units until June 2026. The 2016 Plan established 1,400,000 shares available to grant with a maximum of 400,000 of these shares available to grant as restricted stock awards. Each share issued as a restricted stock award counts as two shares towards the total shares available to award.

Under the 2016 Plan, the vesting date for each option award or restricted stock award is determined by an award committee and specified in the award agreement. In the case of restricted stock awards granted in lieu of cash payments of directors’ fees, the grant date is used as the vesting date unless the award agreement provides otherwise.

As a result of the approval of the 2016 Plan, the First Financial Northwest, Inc. 2008 Equity Incentive Plan (“2008 Plan”) was frozen and no additional awards will be made. At June 30, 2020, there were no unvested shares of restricted stock awards under the 2008 Plan. At this date, there were 8,000 stock options granted under the 2008 Plan that are expected to vest and be available for exercise, and an additional 305,000 stock options from the 2008 Plan were vested and available for exercise at June 30, 2020, subject to the 2008 Plan provisions. At June 30, 2020, there were 1,207,658 total shares available for grant under the 2016 Plan, including 303,829 shares available to be granted as restricted stock.

For the three months ended June 30, 2020 and 2019, total compensation expense for both the 2008 and 2016 Plans was $63,000 and $107,000, respectively, and the related income tax benefit was $13,000 and $22,000, respectively. For the six months ended June 30, 2020 and 2019, total compensation expense for both the 2008 and 2016 Plans was $142,000 and $231,000, respectively, and the related income tax benefit was $30,000 and $48,000, respectively.

32

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Stock Options

Under the 2008 Plan, stock option awards were granted with an exercise price equal to the market price of First Financial Northwest’s common stock at the grant date. These option awards have a vesting period of five years, with 20% vesting on the anniversary date of each grant date, and a contractual life of ten years. Any unexercised stock options expire ten years after the grant date, or sooner in the event of the award recipient’s death, disability or termination of service with the Company and the Bank.

Under the 2016 Plan, the exercise price and vesting period for stock options are determined by the award committee and specified in the award agreement, however, the exercise price shall not be less than the fair market value of a share as of the grant date. Any unexercised stock option will expire 10 years after the award date or sooner in the event of the award recipient’s death, disability, retirement, or termination of service.

The fair value of each option award is estimated on the grant date using a Black-Scholes model that uses the following assumptions. The dividend yield is based on the current quarterly dividend in effect at the time of the grant. Historical employment data is used to estimate the forfeiture rate. The historical volatility of the Company’s stock price over a specified period of time is used for the expected volatility assumption. First Financial Northwest bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices in effect on the date of the grant. First Financial Northwest elected to use the “Share-Based Payments” method permitted by the SEC to calculate the expected term. This method uses the vesting term of an option along with the contractual term, setting the expected life at the midpoint.

Under certain conditions, a cashless exercise of vested stock options may occur by the option holder surrendering the number of options valued at the current stock price at the time of exercise to cover the total cost to exercise. The surrendered options are canceled and are unavailable for reissue.

A summary of the Company’s stock option plan awards and activity for the three and six months ended June 30, 2020, follows: 

	For the Three Months Ended June 30, 2020
	Shares	Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value		Weighted-Average Grant Date Fair Value
Outstanding at April 1, 2020	313,000	$	10.34		$	72,550	$	3.69
Outstanding at June 30, 2020	313,000	10.34		3.48	136,300		3.69
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	312,760	10.34		3.48	136,300		3.69
Exercisable at June 30, 2020	305,000	10.27		3.43	136,300		3.66
	For the Six Months Ended June 30, 2020
	Shares	Weighted-Average Exercise Price		Weighted-Average Remaining Contractual Term in Years	Aggregate Intrinsic Value		Weighted-Average Grant Date Fair Value
Outstanding at January 1, 2020	313,000	$	10.34		$	1,440,310	$	3.69
Outstanding at June 30, 2020	313,000	10.34		3.48	136,300		3.69
Vested and expected to vest assuming a 3% forfeiture rate over the vesting term	312,760	10.34		3.48	136,300		3.69
Exercisable at June 30, 2020	305,000	10.27		3.43	136,300		3.66

33

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of June 30, 2020, there was $14,000 of total unrecognized compensation cost related to nonvested stock options granted under the 2008 Plan. The cost is expected to be recognized over the remaining five months weighted-average vesting period. There were no stock options granted during the six months ended June 30, 2020.

Restricted Stock Awards

The 2016 Plan authorizes the grant of restricted stock awards subject to vesting periods or terms as defined by the award committee and specified in the award agreement. Restricted stock awards granted in lieu of cash payments for directors’ fees are subject to immediate vesting on the grant date unless the award agreement provides otherwise.

A summary of changes in nonvested restricted stock awards for the three and six months ended June 30, 2020, follows: 

	For the Three Months Ended June 30, 2020
	Shares	Weighted-Average Grant Date Fair Value
Nonvested at April 1, 2020	16,228	$	13.61
Nonvested at June 30, 2020	16,228	13.61
Expected to vest assuming a 3% forfeiture rate over the vesting term	15,741	13.61
	For the Six Months Ended June 30, 2020
	Shares	Weighted-Average Grant Date  Fair Value
Nonvested at January 1, 2020	16,698	$	16.53
Granted	16,228	13.61
Vested	(16,698)	16.53
Nonvested at June 30, 2020	16,228	13.61
Expected to vest assuming a 3% forfeiture rate over the vesting term	15,741	13.61

As of June 30, 2020, there was $144,000 of total unrecognized compensation costs related to nonvested shares granted as restricted stock awards. The cost is expected to be recognized over the remaining eight months weighted-average vesting period.

Note 11 - Earnings Per Share

        Per the provisions of FASB ASC 260, Earnings Per Share, nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of EPS pursuant to the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Certain of the Company’s nonvested restricted stock awards qualify as participating securities.

        Net income is allocated between the common stock and participating securities pursuant to the two-class method, based on their rights to receive dividends, participate in earnings, or absorb losses. Basic earnings per common shares is computed by dividing net earnings available to common shareholders by the weighted-average number of common shares outstanding during the period, excluding participating nonvested restricted shares.

34

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

        The following table presents a reconciliation of the components used to compute basic and diluted earnings per share for the periods indicated:

	Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019
	(Dollars in thousands, except share data)
Net income	$	2,143	$	3,304	$	3,827	$	5,249
Less: Earnings allocated to participating securities	(3)		(5)		(6)		(8)
Earnings allocated to common shareholders	$	2,140	$	3,299	$	3,821	$	5,241
Basic weighted average common shares outstanding	9,808,854		9,952,419		9,852,544		10,034,895
Dilutive stock options	10,810		91,000		34,305		90,372
Dilutive restricted stock grants	—		2,936		3,390		6,840
Diluted weighted average common shares outstanding	9,819,664		10,046,355		9,890,239		10,132,107
Basic earnings per share	$	0.22	$	0.33	$	0.39	$	0.52
Diluted earnings per share	$	0.22	$	0.33	$	0.39	$	0.52

        Potential dilutive shares are excluded from the computation of earnings per share if their effect is anti-dilutive. For the three months ended June 30, 2020 and 2019, there were 244,228 and 50,000 options to purchase shares of common stock, respectively, that were omitted from the computation of diluted earnings per share because their effect would be anti-dilutive. For the six months ended June 30, 2020 and 2019, there were 56,228 and 50,000 options to purchase shares of common stock, respectively, that were omitted from the computation of diluted earnings per share because their effect would be anti-dilutive.

Note 12 - Revenue Recognition

        In accordance with Topic 606, revenues are recognized when goods or services are transferred to the customer in exchange for the consideration the Company expects to be entitled to receive. To determine the appropriate recognition of revenue for transactions within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with the customer; (ii) identify the separate performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the separate performance obligations in the contract; and (v) recognize revenue when the entity satisfies a performance obligation. A contract may not exist if there are doubts as to collectability of the amounts the Company is entitled to in exchange for the goods or services transferred. If a contract is determined to be within the scope of Topic 606, the Company recognizes revenue as it satisfies a performance obligation. The largest portion of the Company’s revenue is from net interest income which is not within the scope of Topic 606.

35

FIRST FINANCIAL NORTHWEST, INC. AND SUBSIDIARIES

SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Disaggregation of Revenue

        The following table includes the Company’s noninterest income disaggregated by type of service for the three and six months ended June 30, 2020 and 2019:

	Three Months Ended				Six Months Ended
	June 30, 2020		June 30, 2019		June 30, 2020		June 30, 2019
	(In thousands)
Loss on sale of investments (1)	$	69	$	—	$	69	$	(8)
BOLI change in cash surrender value (1)	254		189		509		458
Wealth management revenue	183		261		348		457
Deposit related fees	79		88		146		157
Debit card and ATM fees	105		117		213		219
Loan related fees	78		119		470		166
Loan interest swap fees	19		90		19		106
Other	2		15		4		24
Total noninterest income	$	789	$	879	$	1,778	$	1,579

_______________

⁽¹⁾ Not within scope of Topic 606

        For the three and six months ended June 30, 2020 and 2019, substantially all of the Company’s revenues under the scope of Topic 606 are for performance obligations satisfied at a specified date.

Revenues recognized within scope of Topic 606

Wealth management revenue: Our wealth management revenue consists of commissions received on the investment portfolio managed by Bank personnel but held by a third party. Commissions are earned on brokerage services and advisory services based on contract terms at the onset of a new customer’s investment agreement or quarterly for ongoing services. Commissions are paid by the third party to the Bank when the performance obligation has been completed by both entities.

Deposit related fees: Fees are earned on our deposit accounts for various products or services performed for our customers. Fees include business account fees, non-sufficient fund fees, stop payment fees, wire services, safe deposit box, and others. These fees are recognized on a daily or monthly basis, depending on the type of service.

Debit card and ATM fees: Fees are earned when a debit card issued by the Bank is used or when other bank’s customers use our ATM services. Revenue is recognized at the time the fees are collected from the customer’s account or remitted by the VISA interchange network.

Loan related fees: Noninterest fee income is earned on our loans for servicing or annual fees on certain loan types.

Loan interest swap fees: For loans participating in an interest rate swap agreement, fees are earned at the onset of the agreement and are not contingent on any future performance or term length of the loan itself. The performance obligation is satisfied by entering into the contract and receipt of the fees from the counterparty.

Other: Fees earned on other services, such as merchant services or occasional non-recurring type services, are recognized at the time of the event or the applicable billing cycle.

Contract Balances

        At June 30, 2020, the Company had no contract liabilities where the Company had an obligation to transfer goods or services for which the Company had already received consideration. In addition, the Company had no material performance obligations as of this date.  

36

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Certain matters discussed in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors including, but not limited to: the effect of the COVID-19 pandemic, including on our credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate customers, including economic activity, employment levels and market liquidity; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs, that may be affected by deterioration in the housing and commercial real estate markets, and may lead to increased losses and nonperforming assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Federal Reserve Bank of San Francisco (“FRB”) and our bank subsidiary by the Federal Deposit Insurance Corporation (“FDIC”), the Washington State Department of Financial Institutions, Division of Banks (“DFI”) or other regulatory authorities, including the possibility that any such regulatory authority may initiate an enforcement action against the Company or the Bank which could require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position, affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings; our ability to pay dividends on our common stock; our ability to attract and retain deposits; increases in premiums for deposit insurance; our ability to control operating costs and expenses; the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our balance sheet; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges; disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement a branch expansion strategy; our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired or may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; our ability to manage loan delinquency rates; costs and effects of litigation, including settlements and judgments; increased competitive pressures among financial services companies; changes in consumer spending, borrowing and savings habits; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules, including as a result of Basel III; the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and the implementing regulations; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; the economic impact of war or any terrorist activities; other economic, competitive, governmental, regulatory, and technological factors affecting our operations; pricing, products and services, including the potential effects of the COVID-19 pandemic, and other risks detailed in our filings with the U.S. Securities and Exchange Commission (“SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”). Any of the forward-looking statements that we make in this Form 10-Q and in the other public reports and statements we make may turn out to be wrong because of the inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward-looking statements made by or on our behalf.

37

Therefore, these factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any forward-looking statements.

As used throughout this report, the terms “Company”, “we”, “our”, or “us” refer to First Financial Northwest, Inc. and its consolidated subsidiaries, including First Financial Northwest Bank and First Financial Diversified Corporation.

Overview

First Financial Northwest Bank (“the Bank”) is a wholly-owned subsidiary of First Financial Northwest, Inc. (“the Company”) and, as such, comprises substantially all of the activity for the Company. First Financial Northwest Bank was a community-based savings bank until February 4, 2016, when the Bank converted to a Washington chartered commercial bank reflecting the commercial banking services it now provides to its customers. The Bank primarily serves King, Pierce, Snohomish, and Kitsap counties, Washington, through its full-service banking office and headquarters in Renton, Washington, as well as six retail branches in King County, Washington, five retail branches in Snohomish County, Washington, and one retail branch in Pierce County, Washington. The Bank has received FDIC approval to open new branches in Gig Harbor, Washington, located in Pierce County and Issaquah, Washington, located in King County. Gig Harbor and Issaquah branches are scheduled to open in late 2020 and early 2021, respectively.

The Bank’s business consists predominantly of attracting deposits from the general public, combined with borrowing from the FHLB and raising funds in the wholesale market (including brokered deposits), then utilizing these funds to originate one-to-four family residential, multifamily, commercial real estate, construction/land, business, and consumer loans. We anticipate that construction/land lending will continue to be a strong element of our total loan portfolio in future periods. We will continue to take a disciplined approach in our construction/land lending by concentrating our efforts on residential loans to builders known to us, including multifamily loans to developers with proven success in this type of construction. These loans typically mature in six to eighteen months and funding is usually not fully disbursed at origination, therefore the impact to net loans receivable is generally minimal in the short term. We have also geographically expanded our loan portfolio through loan purchases or loan participations of commercial and multifamily real estate loans and consumer loans that are outside of our primary market area. Through our efforts to geographically diversify our loan portfolio with direct loan originations, loan participations, or loan purchases, our portfolio includes loans in 42 other states, including concentrations in California, Utah, Oregon and Florida of $44.2 million, $16.2 million, $11.6 million and $8.4 million, respectively.

The Bank’s strategic initiatives seek to diversify our loan portfolio and broaden growth opportunities with our current risk tolerance levels and asset/liability objectives. The Bank has created a SBA department, with the goal of achieving SBA preferred lender status in 2021, which would provide the Bank with delegated loan approval as well as closing and most servicing and liquidation authority, enabling the Bank to make loan decisions more rapidly. In addition, the Bank plans to increase originations of the business loan portfolio, which may include business lines of credit, business term loans, equipment financing, and a focus on industry specific loans, such as green energy financing. In conjunction with the growth of business loans, the Bank seeks to service these customers with their business deposits as well.

Our primary source of revenue is interest income, which is the income that we earn on our loans and investments. Interest expense is the interest that we pay on our deposits and borrowings. Net interest income is the difference between interest income and interest expense. Changes in levels of interest rates affect interest income and interest expense differently and, thus, impacts our net interest income. First Financial Northwest Bank is generally liability-sensitive, meaning our interest-bearing liabilities reprice at a faster rate than our interest-earning assets.

An offset to net interest income is the provision for loan losses which is required to establish the ALLL at a level that adequately provides for probable losses inherent in our loan portfolio. As our loan portfolio increases, or due to an increase for probable losses inherent in our loan portfolio, our ALLL may increase, resulting in a decrease to net interest income. Improvements in loan risk ratings, increases in property values, or receipt of recoveries of amounts previously charged off may partially or fully offset any increase to ALLL due to loan growth or an increase in probable loan losses.

Noninterest income is generated from various loan or deposit fees, increases in the cash surrender value of BOLI, and revenue earned on our wealth management brokerage services. This income is increased or partially offset by any net gain or loss on sales of investment securities.

38

Our noninterest expenses consist primarily of salaries and employee benefits, professional fees, regulatory assessments, occupancy and equipment, and other general and administrative expenses. Salaries and employee benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement, and other employee benefits. Professional fees include legal services, auditing and accounting services, computer support services, and other professional services in support of strategic plans. Occupancy and equipment expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of real estate taxes, depreciation expenses, maintenance, and costs of utilities. Also included in noninterest expense is the change to the Company’s unfunded commitment reserve which is reflected in general and administrative expenses. This unfunded commitment reserve expense can vary significantly each quarter, based on the amount believed by management to be sufficient to absorb estimated probable losses related to unfunded credit facilities, and reflects changes in the amounts that the Company has committed to fund but has not yet disbursed.

COVID-19 Related Information

In response to the COVID-19 pandemic, the Bank is committed to providing assistance to its customers. Under the CARES Act, the Bank is providing certain short-term loan modifications. In addition, the Bank is participating in the Paycheck Protection Program (“PPP”) as a lender. As of June 30, 2020, the Bank had funded 455 applications totaling $51.7 million of loans in its market areas through the PPP program. A majority of the PPP applications have been for our existing customers, however we are also serving those in our community who have not had a banking relationship with us in the past. We are also working with our customers to assist them with accessing other borrowing options, including SBA and other government sponsored lending programs, as appropriate.

        The CARES Act provided that short-term modifications of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term modifications (e.g. generally up to 6 months) such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. To qualify as an eligible loan under the CARES Act, a loan modification must be (1) related to the COVID-19 pandemic; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency by the President or (B) December 31, 2020. The primary method of relief granted by the Company at this time is to allow the borrower to defer their loan payments for three to six months. Certain borrowers will be allowed to pay interest only or have payment deferrals for periods longer than six months after a review of their specific circumstances. Deferred principal and interest amounts are added as a balloon payment due at the original maturity date or payoff of the loan. As of June 30, 2020, the Bank had approved 134 requests for loan modifications by borrowers adversely impacted by the COVID-19 pandemic. The following table shows the term of COVID-19 pandemic relief modifications granted to our borrowers, and the loan balance as of the modification date, in accordance with the CARES Act:

39

	As of June 30, 2020
	Balance of loans with modifications up to 3 months		Balance of loans with modifications 3 - 9 months		Total balance of loans with modifications granted		Total loans as of June 30, 2020		Modifications as % of total loans as of June 30, 2020
	(Dollars in thousands)
One-to-four family residential	$	20,605	$	7,367	27,972		$	382,213	7.3	%
Multifamily	4,657		2,877		7,534		159,371		4.7
Commercial real estate:
Office	2,408		—		2,408		83,439		2.9
Retail	16,094		7,636		23,730		121,936		19.5
Mobile home park	—		—		—		25,961		—
Hotel/motel	996		39,027		40,023		68,165		58.7
Nursing home	5,400		6,368		11,768		11,768		100.0
Warehouse	—		8,796		8,796		17,422		50.5
Storage	—		—		—		36,266		—
Other non-residential	2,114		—		2,114		25,793		8.2
Total Commercial real estate	27,012		61,827		88,839		390,750		22.7
Construction/land	1,100		—		1,100		96,497		1.1
Business
Aircraft	1,364		—		1,364		15,460		8.8
SBA	—		—		—		737		—
PPP	—		—		—		51,661
Other business	2,065		657		2,722		18,212		14.9
Total business	3,429		657		4,086		86,070		4.7
Consumer:
Classic/collectible auto	1,831		—		1,831		24,767		7.4
Other consumer	760		—		760		14,464		5.3
Total consumer	2,591		—		2,591		39,231		6.6
Total loans with COVID-19 pandemic modifications	$	59,394	$	72,728	$	132,122	$	1,154,132	11.4	%

        Prior to their modifications, the loans included in the above table were current on their loan payments. The Bank is monitoring its loan portfolio for delinquencies of loans that have not requested modifications under the CARES Act. As of July 16, 2020, $16.6 million in loans included in the above table for loans which the deferral period was completed had made their scheduled payment. At that date, extension requests were completed or in process on eight loans with a total balance of $11.2 million.

Critical Accounting Policies

        Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and our financial results. These policies are critical because they require management to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or by using different assumptions. These policies govern the ALLL, the valuation of OREO, and the calculation of deferred taxes, the right-of-use asset and lease liability on our operating leases, fair values, and other-than-temporary impairments on the market value of investments and derivatives. These policies and estimates are described in further detail in Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 1, Summary of Significant Accounting Policies in the 2019 Form 10-K. There have not been any material changes in the Company’s critical accounting policies and estimates as compared to the disclosure contained in the 2019 Form 10-K.

40

Comparison of Financial Condition at June 30, 2020 and December 31, 2019

Total assets were $1.42 billion at June 30, 2020, an increase of 5.7%, from $1.34 billion at December 31, 2019. The following table details the $76.5 million net change in the composition of our assets at June 30, 2020 from December 31, 2019.

	Balance at June 30, 2020		Change from December 31, 2019		Percent Change
	(Dollars in thousands)
Cash on hand and in banks	$	7,688	$	(2,406)	(23.8)	%
Interest-earning deposits with banks	66,250		53,354		413.7
Investments available-for-sale, at fair value	128,874		(7,727)		(5.7)
Investment held-to-maturity	2,395		2,395		n/a
Loans receivable, net	1,138,243		29,781		2.7
FHLB stock, at cost	6,410		(599)		(8.5)
Accrued interest receivable	4,981		843		20.4
Deferred tax assets, net	2,007		506		33.7
OREO	454		—		—
Premises and equipment, net	22,222		(244)		(1.1)
BOLI	32,561		579		1.8
Prepaid expenses and other assets	1,513		(703)		(31.7)
ROU	2,972		763		34.5
Goodwill	889		—		—
Core deposit intangible	896		(72)		(7.4)
Total assets	$	1,418,355	$	76,470	5.7	%

Interest-earning deposits with banks. Our interest-earning deposits with banks, consisting primarily of funds held at the Federal Reserve Bank of San Francisco (“FRB”), increased by $53.4 million during the six months ended June 30, 2020. Deposit growth of $92.6 million outpaced the growth in loans receivable providing excess funds invested in these deposits and funding for the payoff of certain borrowings.

Investments available-for-sale. Our investments available-for-sale portfolio decreased by $7.7 million during the six months ended June 30, 2020. As part of a strategy to diversify the Bank’s holdings of subordinated debt obligations from financial institutions, during this period the Bank sold $3.0 million of subordinated debt obligations issued by one institution, and purchased a total of $3.0 million of subordinated debt obligations issued by two different financial institutions. Following this restructure, the Bank’s maximum investment in a single financial institution was $2.0 million. In addition, the Bank sold one mortgage backed security for $3.2 million. These transactions resulted in a net gain on sale of $69,000. At June 30, 2020, corporate bonds issued by financial institutions represented $21.8 million, or 16.9% of our investments available-for-sale and municipal bonds represented $14.2 million, or 11.0% of our investments available-for-sale.

The effective duration of the investments available-for-sale at June 30, 2020, was 2.75% as compared to 2.54% at December 31, 2019. Effective duration measures the anticipated percentage change in the value of an investment security (or portfolio) in the event of a 100 basis point change in market yields. Since the Bank’s portfolio includes securities with embedded options (including call options on bonds and prepayment options on mortgage-backed securities), management believes that effective duration is an appropriate metric to use as a tool when analyzing the Bank’s investment securities portfolio, as effective duration incorporates assumptions relating to such embedded options, including changes in cash flow assumptions as interest rates change.

41

Loans receivable. Total loans receivable increased by $31.9 million during the six months ended June 30, 2020, to $1.2 billion at June 30, 2020. The primary factor behind the increase was the origination of $51.7 million in SBA approved PPP loans. Loan originations of $150.6 million were supplemented with $11.3 million of loan purchases. During the six months ended June 30, 2020, business loans increased by $48.3 million, one-to-four family residential loans increased by $9.7 million and consumer loans increased by $9.0 million. Partially offsetting these increases, construction/land loans decreased by $17.2 million, multifamily loans decreased by $13.5 million and commercial real estate loans decreased by $4.4 million,

Our loan concentrations remained stable at June 30, 2020 as compared to December 31, 2019. At these dates, the Bank’s construction loans totaled 67.3% and 81.9% of total capital, respectively, and total non-owner occupied commercial real estate was 420.7% and 449.7% of total capital, respectively. The Bank has set aggregate concentration guidelines that total commercial real estate, including residential, non-residential, and construction loans, should not exceed 550% of total risk-based capital. Our concentration guideline for construction/land loans is to limit these loans to 100% of total risk-based capital. The concentration of construction/land loans is calculated using the funded balance of these loans and consequently can fluctuate based on the timing of construction draws and loan payoffs. Management reviews estimated construction draws and loan payoffs and adjusts loan originations based on these estimates to achieve compliance with our construction guidelines. Our commercial and multifamily real estate and construction/land loan portfolios are subject to ongoing credit reviews performed by both independent loan review staff, as well as an external third-party review firm to assist with identifying potential adverse trends and risks in the portfolio allowing management to initiate timely corrective action, as necessary. Such reviews also assist with ensuring loan risk grades are accurately assigned and thereby properly accounted for in the ALLL. The review places emphasis on large borrowing relationships, stress testing, compliance with loan covenants, as well as other risk factors warranting enhanced review.

The following table presents a breakdown of our multifamily, commercial and construction loans by collateral type at June 30, 2020 and December 31, 2019. Total construction/land loans are net of $78.9 million and $89.6 million of LIP at June 30, 2020 and December 31, 2019, respectively.

	June 30, 2020		December 31, 2019
	(In thousands)
Multifamily residential:
Micro-unit apartments	$	11,177	$	13,809
Other multifamily	148,194		159,106
Total multifamily residential	159,371		172,915
Non-residential
Office	83,439		100,744
Retail	121,936		133,094
Mobile home park	25,961		26,099
Hotel / motel	68,165		42,971
Nursing home	11,768		11,831
Warehouse	17,422		17,595
Storage	36,266		37,190
Other non-residential	25,793		25,628
Total non-residential	390,750		395,152
Construction/land:
One-to-four family residential	45,128		44,491
Multifamily	40,120		40,954
Commercial	6,134		19,550
Land	5,115		8,670
Total construction/land	96,497		113,665
Total multifamily residential, non-residential and construction/land loans	$	646,618	$	681,732

42

Included in total construction/land loans at June 30, 2020, are $37.4 million of multifamily loans, $6.1 million of commercial real estate loans and $2.1 million of one-to-four family loans that will roll over to permanent loans at the completion of their construction period in accordance with the terms of the construction/land loan. At December 31, 2019, construction/land loans included $38.6 million of multifamily loans, $18.3 million of commercial real estate loans and $3.5 million of one-to-four family loans that roll over to permanent loans in accordance with the terms of the construction/land loan.

To assist in our strategic initiatives for loan growth and to achieve geographic diversification, the Bank will originate and purchase loans and utilize loan participations with the underlying collateral located within areas of Washington State outside our primary market area or in other states. The Bank’s goal with respect to loan participations is to locate a selling bank that is unable to make an entire loan due to legal or lending concentration limitations. Sellers of these loans are reviewed for management/lending experience, financial condition, asset quality metrics, and regulatory matters. Loans acquired through participation or purchase must meet the Bank’s underwriting standards. During the six months ended June 30, 2020, the Bank purchased $10.1 million of consumer loans secured by classic/collectible automobiles to borrowers located in Washington and other states.

The majority of our loan portfolio continues to be secured by properties located in our primary market area, however a significant amount is secured by properties in other areas of Washington, in California, and in other states. At June 30, 2020, total loans secured by collateral located in California represented 3.8% of our total loans and total loans secured by collateral located outside the states of California and Washington represented 9.6% of our total loans. The following table details geographic concentrations in our loan portfolio:

	At June 30, 2020
	One-to-Four Family Residential		Multifamily		Commercial Real Estate		Construction/Land		Business		Consumer		Total
	(In thousands)
King County	$	298,184	$	90,073	$	223,168	$	87,198	$	54,358	$	12,476	$	765,457
Pierce County	35,202		4,717		26,558		5,791		2,464		425		75,157
Snohomish County	29,137		4,385		12,946		1,259		15,927		1,393		65,047
Kitsap County	7,785		5		298		2,249		650		—		10,987
Other Washington Counties	8,670		23,628		48,930		—		504		437		82,169
California	2,650		20,279		15,397		—		981		4,889		44,196
Outside Washington and California (1)	585		16,284		63,453		—		11,186		19,611		111,119
Total loans	$	382,213	$	159,371	$	390,750	$	96,497	$	86,070	$	39,231	$	1,154,132

_______________

⁽¹⁾ Includes loans in Utah, Oregon and Florida of $16.2 million, $11.6 million and $8.4 million, respectively, and loans in 38 other states.

Our five largest borrowing relationships, which represent 7.8% of our net loans, increased by $2.8 million to $89.7 million at June 30, 2020, from $86.9 million at December 31, 2019. The total number of loans represented by this group of borrowers decreased slightly to 14 loans at June 30, 2020, from 16 loans at December 31, 2019. At June 30, 2020, all five borrowers were current on their loan payments. We monitor the performance of these borrowing relationships very closely due to their concentration risk in relation to the entire loan portfolio.

43

The following table details our five largest lending relationships at June 30, 2020:

Borrower (1)	Number of Loans	One-to-Four Family Residential (2)		Multifamily		Commercial Real Estate		Business		Aggregate Balance of Loans
	(Dollars in thousands)
Real estate investor	5	$	—	$	8,339	$	12,897	$	—	$	21,236
Real estate investor	5	427		—		18,628		—		19,055
Real estate investor	2	—		—		18,539		—		18,539
Real estate investor	1	—		—		15,619		—		15,619
Real estate investor	1	—		—		—		15,272		15,272
Total	14	$	427	$	8,339	$	65,683	$	15,272	$	89,721

________

⁽¹⁾  The composition of borrowers represented in the table may change between periods.

⁽²⁾ The one-to-four family residential loan is an owner occupied property. The commercial real estate loans are for non-owner occupied properties.

The ALLL increased to $13.8 million at June 30, 2020, from $13.2 million at December 31, 2019, and represented 1.20% and 1.18% of total loans receivable at June 30, 2020, and December 31, 2019, respectively. The ALLL consists of two components, the general allowance and the specific reserves. The increase in the ALLL general allowance was primarily the result of increases in forecasted credit deterioration for all loan categories in response to the economic disruption caused by the COVID-19 pandemic, with higher potential impact allocated to commercial real estate and construction/land portfolios. The $51.7 million balance of PPP loans was omitted from the ALLL calculation at June 30, 2020 as these loans are fully guaranteed by the SBA. Management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reimburse the Bank for the amount forgiven. Impaired loans increased $2.1 million during the six months ended June 30, 2020, however, the loans are generally well collateralized and did not require additional reserves to be set aside. The specific reserves decreased by $16,000 as a result of amortization of the additional allowance set aside on loans with modifications and loan payoffs. For additional information, see “Comparison of Operating Results for the Three Months Ended June 30, 2020 and 2019 - Provision for Loan Losses” and “Comparison of Operating Results for the Six Months Ended June 30, 2020 and 2019 - Provision for Loan Losses” discussed below.

We believe that the ALLL at June 30, 2020, was adequate to absorb the probable and inherent risks of loss in the loan portfolio at that date. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will be proven correct in the future, that the actual amount of future losses will not exceed the amount of past provisions, or that any increased provisions that may be required will not adversely impact our financial condition and results of operations. Future additions to the allowance may become necessary based upon changing economic conditions, the level of problem loans, business conditions, credit concentrations, increased loan balances, or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of our ALLL is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional loss reserves or the charge-off of specific loans against established loss reserves based upon their judgment of information available to them at the time of their examination. Uncertainties relating to our ALLL are heightened as a result of the risks surrounding the COVID-19 pandemic as described in further detail in Part II, Item 1A.

As we work with our borrowers that face difficult financial circumstances, we explore various options available to minimize our risk of loss. At times, the best option for our customers and the Bank is to modify the loan for a period of time, usually one year or less. Certain loan modifications are accounted for as TDRs. These modifications have included a reduction in interest rate on the loan for a period of time, advancing the maturity date of the loan, or allowing interest-only payments for a specific time frame. These modifications are granted only when there is a reasonable and attainable restructured loan plan that has been agreed to by the borrower and is considered to be in the Bank’s best interest. As discussed above, loans modified in accordance with the CARES Act are not considered TDRs.

44

The following table presents a breakdown of our TDRs at the dates indicated, all of which were performing:

	June 30, 2020			December 31, 2019			Six Month Change
	(Dollars in thousands)
Performing TDRs:
One-to-four family residential	$	2,997		$	3,979		$	(982)
Commercial real estate	1,254			1,267			(13)
Total TDRs	$	4,251		$	5,246		$	(995)
% TDRs classified as performing	100.0		%	100.0		%

        Our TDRs decreased $995,000 at June 30, 2020, compared to December 31, 2019, as a result of principal repayments and loan payoffs. At June 30, 2020, all TDRs were performing and on accrual status. In addition, there were no committed but undisbursed funds in connection with our TDRs. The largest TDR relationship at June 30, 2020, totaled $1.3 million and was secured by a commercial property located in King County.

        Loans are considered past due if a scheduled principal or interest payment is due and unpaid for 30 days or more. At both June 30, 2020, and December 31, 2019, total past due loans were $2.1 million, representing 0.18% and 0.19% of total loans receivable, respectively.

        Nonperforming assets increased by $2.1 million during the first six months of 2020, primarily as a result of a $2.1 million multifamily loan that was moved to nonaccrual status during this period. The following table presents detailed information on our nonperforming assets at the dates indicated:

	June 30, 2020			December 31, 2019			Six Month Change
	(Dollars in thousands)
Nonaccrual loans:
One-to-four family residential	$	87		$	95		$	(8)
Multifamily	2,104			—			2,104
Total nonaccrual loans	2,191			95			2,096
OREO	454			454			—
Total nonperforming assets (1)	$	2,645		$	549		$	2,096
Nonperforming assets as a percent of total assets	0.19		%	0.04		%

^____________

⁽¹⁾ The difference between nonperforming assets reported above, and the totals reported by other industry sources, is due to their inclusion of all TDRs as nonperforming loans, although 100.0% of our TDRs were performing in accordance with their restructured terms at June 30, 2020.

        Nonaccrual loans are loans that are 90 days or more delinquent or other loans which, in management's opinion, the borrower is unable to meet scheduled payment obligations. The largest nonaccrual loan at June 30, 2020 was a $2.1 million multifamily loan secured by a non-owner occupied multifamily residence located in King County. Foreclosure proceedings are underway on this loan as it was more than 90 days past due at June 30, 2020. Also included in nonaccrual loans at June 30, 2020, was a $87,000 owner occupied, single-family residence located in Snohomish County. This loan was current on its loan payments at that date.

We continue to focus our efforts on working with borrowers to bring their loans current or converting nonaccrual loans to OREO and subsequently selling the properties. By taking ownership of these properties, we can generally convert non-earning assets into earning assets on a more timely basis than which may otherwise be the case. Our success in this area is reflected by the low ratio of our nonperforming assets as a percent of total assets of 0.19% at June 30, 2020, and 0.04% at December 31, 2019, as well as the minimal amount of OREO held at June 30, 2020.

45

OREO. OREO includes properties acquired by the Bank through foreclosure or acceptance of a deed in lieu of foreclosure. At both June 30, 2020, and December 31, 2019, OREO was $454,000, and consisted of two undeveloped commercial lots located in Pierce County.

        Intangible assets. The balance of goodwill was $889,000 at both June 30, 2020 and December 31, 2019. Goodwill was calculated as the excess purchase price of the branches acquired in August 2017 (the “Branch Acquisition”) over the fair value of the assets acquired and liabilities assumed.

        The core deposit intangible (“CDI”) recorded as part of the Branch Acquisition represents the fair value of the customer relationships on the acquired noninterest-bearing demand, interest-bearing demand, savings, and money market accounts. The CDI balance was $896,000 at June 30, 2020 and $968,000 at December 31, 2019. The initial ratio of CDI to the acquired balances of core deposits was 2.23%. This amount amortizes into noninterest expense on an accelerated basis over ten years.

        As a result of the economic disruption caused by the COVID-19 pandemic, the Company performed an interim impairment analysis on goodwill and the CDI during the second quarter of 2020. Management has determined that at June 30, 2020, it was premature to determine potential sustained deterioration in the fair value of the Company and did not recognize any impairment on goodwill or the CDI. Additional analysis will be performed as required as more information on the economic impact of the COVID-19 pandemic is known.

Deposits. During the first three months of 2020, deposits increased $92.6 million to $1.13 billion at June 30, 2020, compared to $1.03 billion at December 31, 2019. Deposit accounts consisted of the following:

	June 30, 2020		Change from December 31, 2019		Percent Change
	(Dollars in thousands)
Noninterest-bearing demand	$	91,593	$	38,744	73.3	%
Interest-bearing demand	102,707		36,810		55.9
Statement savings	18,946		1,499		8.6
Money market	429,987		52,221		13.8
Certificates of deposit, retail	450,487		25,384		6.0
Certificates of deposit, brokered	32,448		(62,024)		(65.7)
	$	1,126,168	$	92,634	9.0

        Our retail deposits increased by $154.7 million during the six months ended June 30, 2020. Money market accounts increased by $52.2 million and retail certificates of deposit increased by $25.4 million as the Bank competitively priced these products to increase these funding sources. In addition, noninterest-bearing demand and interest-bearing demand accounts increased by $38.7 million and $36.8 million, respectively, due in part to deposits related to PPP loans funded during the second quarter of 2020.

        The Bank’s portfolio of brokered certificates of deposits decreased by $62.0 million to $32.4 million at June 30, 2020, from $94.5 million at December 31, 2019. Continued growth in retail deposits with our expanded branch network allowed the Bank to reduce brokered deposits as a source of funds. To assist in management of our interest rate risk, $67.5 million of maturing brokered certificates of deposit were partially replaced with FHLB borrowings hedged by interest rate swap agreements. In addition, $9.5 million of callable brokered certificates of deposit, with a weighted average interest rate of 2.43%, were redeemed early. The Bank’s current portfolio of brokered certificates of deposit will mature in one month to 4.8 years.

At June 30, 2020 and December 31, 2019, we held $52.7 million and $34.0 million in public funds, respectively, primarily in retail certificates of deposit and money market accounts.

46

Advances. We use advances from the FHLB as an alternative funding source to manage interest rate risk and to leverage our balance sheet and to supplement our deposits. Total FHLB advances were $120.0 million at June 30, 2020, a $17.7 million decrease from $137.7 million at December 31, 2019. At June 30, 2020, the Bank’s advances included $60.0 million of fixed-rate three-month advances that renew quarterly, and $60.0 million of fixed-rate one-month advances that renew monthly, that are utilized in cash flow hedge agreements, as described below. At June 30, 2020, all of our FHLB advances were due to reprice in less than two months. At that date, there were no FHLB Fed Funds short-term borrowings.

Cash Flow Hedge. To assist in our interest rate risk management efforts, the Bank has entered into multiple interest rate swap agreements with qualified institutions. Each interest rate swap agreement qualifies as a cash flow hedge of the variability of future interest payments attributable to the changes in 1-month or 3-month LIBOR rates. The objective of the cash flow hedge is to offset the variability of cash flows due to the rollover of the Bank’s FHLB, or other fixed rate advances, for 1-month or 3-months, respectively, for the term of the agreement. The agreements allow for a substitute index to be used if LIBOR is unavailable.

The following table presents details of the Bank’s interest rate swap agreements as of June 30, 2020. For each interest rate swap agreement listed, the Bank has secured a fixed-rate FHLB advance for the notional amount that reprices at the same frequency as the corresponding interest-rate swap. The Bank pays a fixed interest rate to the counterparty and in return, receives a floating interest rate based on the index noted in the below table. The original term of these interest rate swap agreements range from four to eight years.

Notional amount		Start Date	Maturity Date	Fixed rate paid to counterparty		Index rate received from counterparty	Repricing Frequency
(Dollars in thousands)
$	50,000	10/25/2016	10/25/2021	1.340	%	3-month LIBOR	quarterly
15,000		9/27/2019	9/27/2024	1.440		1-month LIBOR	monthly
10,000		11/19/2019	11/20/2023	1.585		3-month LIBOR	quarterly
15,000		3/2/2020	3/2/2026	0.911		1-month LIBOR	monthly
15,000		3/2/2020	3/2/2027	0.937		1-month LIBOR	monthly
15,000		3/2/2020	3/2/2028	0.984		1-month LIBOR	monthly
15,000		10/25/2021	10/25/2028	0.793		3-month LIBOR	quarterly
10,000		10/25/2021	10/25/2029	0.800		3-month LIBOR	quarterly

Interest rate swap agreements in the above table with start dates in 2021 are forward-starting contracts. The Bank intends to secure two fixed-rate FHLB advances on October 25, 2021 for $15.0 million and $10.0 million, for seven years and eight years, respectively, which will reprice quarterly. These forward-starting contracts are intended to partially replace the $50.0 million notional interest rate swap that will mature on October 25, 2021.

A change in the net fair value of these cash flow hedges is recognized as an other asset or other liability on the balance sheet with the tax-effected portion of the change included in other comprehensive income. At June 30, 2020, we recognized a $4.2 million net fair value liability as a result of the decrease in the market value of these interest rate swap agreements.

        Stockholders’ Equity. Total stockholders’ equity decreased $2.3 million during the first six months of 2020 to $154.0 million at June 30, 2020, from $156.3 million at December 31, 2019. Increases to stockholders’ equity included $3.8 million of net income and $785,000 of stock based compensation. These increases were more than offset by a $2.5 million, net of tax, decrease in other comprehensive income as a result of the decline in the fair market value of our available-for-sale securities and cash flow hedges. In addition, stockholders’ equity decreased by $2.4 million from the repurchase of 214,845 shares of common stock and $2.0 million in cash dividends paid. As part of the strategy to increase shareholder value, the Company’s Board of Directors authorized a stock repurchase plan that began on January 27, 2020 and expired on July 27, 2020. The plan authorizes the repurchase of up to 513,000 shares of the Company’s stock. At June 30, 2020, the Company had repurchased 214,845 shares under this repurchase plan at an average price of $11.13 per share.

47

The following table shows cash dividends paid per share and the related dividend payout ratio for the periods indicated:

	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Dividend declared per common share	$	0.10		$	0.09		$	0.20		$	0.17
Dividend payout ratio (1)	45.5		%	27.3		%	51.3		%	32.6		%

______________

⁽¹⁾ Dividends paid per common share divided by basic earnings per common share.  

48

Comparison of Operating Results for the Three Months Ended June 30, 2020 and 2019

General. Net income for the three months ended June 30, 2020, was $2.1 million, or $0.22 per diluted share compared to $3.3 million, or $0.33 per diluted share for the three months ended June 30, 2019. The $1.2 million decrease in net income during the three months ended June 30, 2020, was a primarily a result of the change in the provision for loan losses to a $300,000 provision for the three months ended June 30, 2020 as compared to a $800,000 recapture of provision for the three months ended June 30, 2019.

Net Interest Income. Net interest income for the three months ended June 30, 2020, increased $361,000 to $10.1 million from $9.7 million for the three months ended June 30, 2019 as a result of a decrease in interest expense outpacing the decrease in interest income.

Interest income decreased by $788,000 for the three months ended June 30, 2020, as compared to the same period in 2019, primarily as a result of the significant 150 basis point decrease in the targeted federal funds rate in March 2020 in response to the COVID-19 pandemic. Loan interest income decreased $423,000 for the three months ended June 30, 2020 as compared to the same period in 2019, primarily due to a decrease in yield to 4.72% for the three months ended June 30, 2020 from 5.19% for the three months ended June 30, 2019. Partially offsetting the decrease in yield, the average balance of loans receivable increased $71.0 million for the three months ended June 30, 2020 as compared to the same period in 2019. However, a large portion of this increase was the result of $51.7 million PPP loans originated during the three months ended June 30, 2020. As certain criteria are met, prepayments of these loans or amounts forgiven by the SBA, as certain criteria are met, may increase the loan yield in periods of payoff with recognition of unamortized fees and costs. The impact to our loan yields is expected to cease completely after the payoff or maturity of these loans.

Available-for-sale investments interest income decreased $313,000 primarily as a result of a decrease in yield to 2.41% for the three months ended June 30, 2020 from 3.21% for the three months ended June 30, 2019. In addition, the average balance of these investments decreased $5.6 million for the three months ended June 30, 2020 as compared to the same period in 2019.

Interest income from interest-earning deposits decreased $40,000 for the three months ended June 30, 2020, as a result of a decrease in yield to 0.10% from 2.33% for the three months ended June 30, 2019, outweighing a $22.7 million increase in the average balance of these funds.

The decrease in interest income was more than offset by a $1.1 million decrease in interest expense for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019. Interest expense on interest-bearing deposits decreased 40 basis points for the comparative periods, as a combined result of the declining interest rate environment and an increase in lower-cost demand deposits. Growth in our branch network allowed us to reduce our dependency on higher cost brokered deposits. Interest expense for brokered certificates of deposit decreased by $587,000, primarily as a result of a $95.8 million decrease in the average balance of these deposits for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019. Our cost of funds was also impacted favorably by a 63 basis point decrease in the cost of money market accounts, partially offset by a $97.7 million increase in the average balance of these deposits.

Further contributing to the decrease in interest expense, our cost of borrowings decreased by $485,000 for the three months ended June 30, 2020, as compared to the same period in 2019. Through a combination of lower interest rates on FHLB Fed Funds short-term borrowings, as well as FHLB advances tied to interest rate swap agreements, the Bank’s cost of borrowings decreased to 1.08% for the three months ended June 30, 2020, from 2.28% for the three months ended June 30, 2019.

The Company’s net interest margin decreased by 11 basis points to 3.12% for the three months ended June 30, 2020, as compared to the same period , primarily due to decreases in our yield on interest-earning assets outpacing the decline on our cost of interest-bearing liabilities last year. The decline was a result of the lag in the market’s response to lowering deposit pricing when the targeted federal funds rate decreased in the second half of 2019 and the first quarter of 2020. For more information on this, see “How We Measure the Risk of Interest Rate Changes” in Item 3 of this report.

49

The following table details the change in net interest income due to changes in yield or cost, or changes in the average balance of the related asset or liability:

	Three Months Ended June 30, 2020 Compared to June 30, 2019 Net Change in Interest
	Rate		Volume		Total
	(In thousands)
Interest-earning assets:
Loans receivable, net	$	(1,342)	$	919	$	(423)
Investments available-for-sale	(268)		(45)		(313)
Investments held-to-maturity	9		—		9
Interest-earning deposits with banks	(172)		132		(40)
FHLB stock	(13)		(8)		(21)
Total net change in income on interest-earning assets	(1,786)		998		(788)
Interest-bearing liabilities:
Interest-bearing demand	43		19		62
Statement savings	(3)		(2)		(5)
Money market	(641)		371		(270)
Certificates of deposit, retail	(60)		196		136
Certificates of deposit, brokered	(11)		(576)		(587)
Borrowings	(384)		(101)		(485)
Total net change in expense on interest-bearing liabilities	(1,056)		(93)		(1,149)
Total net change in net interest income	$	(730)	$	1,091	$	361

50

The following table compares detailed average balances, related interest income or interest expense, associated yields and rates, and the resulting net interest margin for the three months ended June 30, 2020 and 2019. Nonaccrual loans are included in the average balance of net loans receivable and are considered to carry a zero yield.

	Three Months Ended June 30,
	2020						2019
	Average Balance		Interest Earned / Paid		Yield / Cost		Average Balance		Interest Earned / Paid		Yield / Cost
	(Dollars in thousands)
Assets
Loans receivable, net	$	1,122,913	$	13,183	4.72	%	$	1,051,894	$	13,606	5.19	%
Investments available-for-sale	133,038		796		2.41		138,634		1,109		3.21
Investments held-to-maturity	2,378		9		1.52
Interest-earning deposits with banks	30,989		8		0.10		8,275		48		2.33
FHLB stock	6,736		81		4.84		7,337		102		5.58
Total interest-earning assets	1,296,054		14,077		4.37		1,206,140		14,865		4.94
Noninterest earning assets	75,215						73,740
Total average assets	$	1,371,269					$	1,279,880
Liabilities and Stockholders' Equity
Interest-bearing demand	$	90,843	$	86	0.38	%	$	51,133	$	24	0.19	%
Statement savings	18,067		3		0.07		23,358		8		0.14
Money market	404,828		896		0.89		307,119		1,166		1.52
Certificates of deposit, retail	442,172		2,490		2.26		408,253		2,354		2.31
Certificates of deposit, brokered	33,639		191		2.28		129,443		778		2.41
Total interest-bearing deposits	989,549		3,666		1.49		919,306		4,330		1.89
Borrowings	128,154		344		1.08		145,895		829		2.28
Total interest-bearing liabilities	1,117,703		4,010		1.44		1,065,201		5,159		1.94
Noninterest bearing liabilities	99,451						62,412
Average equity	154,115						152,267
Total average liabilities and equity	$	1,371,269					$	1,279,880
Net interest income			$	10,067					$	9,706
Net interest margin					3.12	%					3.23	%

Provision for Loan Losses. Management recognizes that loan losses may occur over the life of a loan and that the ALLL must be maintained at a level necessary to absorb specific losses on impaired loans and probable losses inherent in the loan portfolio. Our methodology for analyzing the ALLL consists of two components: general and specific reserves. The general reserve is determined by applying factors to our various groups of loans. Management considers factors such as charge-off history, the prevailing economy, the regulatory environment, competition, geographic and loan type concentrations, policy and underwriting standards, nature and volume of the loan portfolio, managements’ experience level, our loan review and grading systems, the value of underlying collateral and the level of problem loans in assessing the ALLL. The specific reserve component is created when management believes that the collectability of a specific loan has been impaired and a loss is probable or a concession is granted that reduces the value of the loan. The specific reserves are computed using discounted cash flows, current appraisals, listed sales prices, and other available information, less costs to complete, if any, and costs to sell the property. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or if future events differ from current estimates.

51

During the three months ended June 30, 2020, management evaluated the adequacy of the ALLL and concluded that a $300,000 provision for loan losses was appropriate. Factors for economic impact and collateral values for commercial real estate and construction/land portfolios were increased in response to the worsening forecasted economic conditions and uncertainty from the COVID-19 pandemic. In comparison, during the three months ended June 30, 2019, an $800,000 recapture of provision for loan losses was recognized primarily due to an $11.6 million construction loan that was moved to impaired status. The impairment analysis concluded that the Bank did not anticipate incurring losses on the loan and no additional provision was required. For additional information, see Note 5 - Loans Receivable. ALLL.

        The following table summarizes selected financial data related to our ALLL and loan portfolio.

	At or For the Three Months Ended June 30,
	2020			2019
	(Dollars in thousands)
Total loans receivable, end of period	$	1,154,132		$	1,066,301
Average loans receivable during period	1,122,913			1,051,894
ALLL balance at beginning of period	13,530			13,808
Provision (recapture) for loan losses	300			(800)
Charge-offs:
Total charge-offs	—			—
Recoveries:
One-to-four family	6			4
Multifamily	—			45
Total recoveries	6			49
Net recovery	6			49
ALLL balance at end of period	$	13,836		$	13,057
ALLL as a percent of total loans	1.20		%	1.22		%
Ratio of net recoveries to average net loans receivable	—			—

        Noninterest Income. Noninterest income decreased $90,000 to $789,000 for the quarter ended June 30, 2020, from $879,000 for the quarter ended June 30, 2019.

The following table provides a detailed analysis of the changes in the components of noninterest income:

	Three Months Ended June 30, 2020		Change from Three Months Ended June 30, 2019		Percent Change
	(Dollars in thousands)
Net gain on sale of investments	$	69	$	69	n/a
BOLI change in cash surrender value	254		65		34.4
Wealth management revenue	183		(78)		(29.9)
Deposit related fees	184		(21)		(10.2)
Loan related fees	97		(112)		(53.6)
Other	2		(13)		(86.7)
Total noninterest income	$	789	$	(90)	(10.2)	%

        During the three months ended June 30, 2020, as compared to the three months ended June 30, 2019, loan related fees decreased by $112,000, partially as a result of a $71,000 reduction in interest rate swap fees received on loans where certain commercial loan customers participate in an interest rate swap with a third party broker institution and the Bank receives a fee that is recognized as other noninterest income at the time the loan is originated. In addition, loan prepayment fees collected on certain loans paid prior to maturity decreased by $32,000 for the three months ended June 30, 2020 as compared to the same period in 2019. Further contributing to the decrease, wealth management revenue decreased by $78,000, primarily as a result of

52

regular fluctuations in the timing and mix of commissions received on serviced accounts. Partially offsetting these reductions, the change in cash surrender value of our BOLI policies increased by $65,000 and a $69,000 net gain on sales of investments was recognized for the three months ended June 30, 2020. In comparison, no available-for-sale investments were sold during the three months ended June 30, 2019.

        Noninterest Expense. Noninterest expense increased $661,000 to $7.9 million for the three months ended June 30, 2020, from $7.3 million for the comparable period in 2019.

The following table provides a detailed analysis of the changes in the components of noninterest expense:

	Three Months Ended June 30, 2020		Change from Three Months Ended June 30, 2019		Percent Change
	(Dollars in thousands)
Salaries and employee benefits	$	4,801	$	67	1.4	%
Occupancy and equipment	1,031		133		14.8
Professional fees	455		129		39.6
Data processing	687		290		73.0
OREO related expenses, net	5		4		400.0
Regulatory assessments	127		(9)		(6.6)
Insurance and bond premiums	103		15		17.0
Marketing	29		(47)		(61.8)
Other general and administrative	706		79		12.6
Total noninterest expense	$	7,944	$	661	9.1	%

Continued branch expansion resulted in an increase of $133,000 in occupancy and equipment expenses for the three months ended June 30, 2020, as compared to the same period in 2019. The addition of a new online banking platform resulted in a $129,000 increase in professional fees and $290,000 increase in data processing fees to support the implementation of this project. Partially offsetting these increases, marketing expense decreased by $47,000 for the three months ended June 30, 2020, as compared to the same period in 2019, due primarily to cancellations of sponsored events due to COVID-19 restrictions. 

Federal Income Tax Expense. The federal income tax provision decreased by $329,000 to $469,000 for the three months ended June 30, 2020, as compared to $798,000 for the same period in 2019, primarily due to a $1.5 million decrease in income before federal income taxes.

Comparison of Operating Results for the Six Months Ended June 30, 2020 and 2019

General. Net income for the six months ended June 30, 2020 was $3.8 million, or $0.39 per diluted share as compared to net income of $5.2 million, or $0.52 per diluted share for the six months ended June 30, 2019. The decrease during the six months ended June 30, 2020, was partially the result of the change in loan loss provision to a $600,000 provision for the six months ended June 30, 2020 as compared to a $400,000 recapture of provision for the six months ended June 30, 2019. In addition, noninterest expense increased by $1.2 million for the six months ended June 30, 2020 as compared to the same period in 2019.

Net Interest Income. Net interest income for the six months ended June 30, 2020 was $19.7 million, as compared to $19.6 million for the same period in 2019, with decreases in interest income and interest expense of $859,000 and $1.0 million, respectively.

Interest income decreased by $859,000 for the six months ended June 30, 2020, as compared to the same period in 2019, primarily as a result of the significant 150 basis point decrease in the targeted federal funds rate in March 2020 in response to the COVID-19 pandemic. Loan interest income decreased $230,000 for the six months ended June 30, 2020 as compared to the same period in 2019, primarily due to a decrease in yield to 4.83% for the six months ended June 30, 2020 from 5.20% for the six months ended June 30, 2019. Partially offsetting the decrease in yield, the average balance of loans receivable increased $67.5 million for the six months ended June 30, 2020 as compared to the same period in 2019. However, a large portion of this increase was the result of $51.7 million PPP loans originated during the three months ended June 30, 2020. As certain criteria are met, prepayments of these loans or amounts forgiven by the SBA, as certain criteria are met, may

53

increase the loan yield in periods of payoff with recognition of unamortized fees and costs. The impact to our loan yields is expected to cease completely after the payoff or maturity of these loans.

Further contributing to the decrease in interest income, available-for-sale investments interest income decreased $553,000 primarily as a result of a decrease in yield to 2.57% for the six months ended June 30, 2020 from 3.28% for the six months ended June 30, 2019. In addition, the average balance of these investments decreased $5.1 million for the six months ended June 30, 2020 as compared to the same period in 2019.

Interest income from interest-earning deposits decreased $51,000 for the six months ended June 30, 2020, as a result of a decrease in yield to 0.36% from 2.40% for the six months ended June 30, 2019, which more than offset the impact from a $13.4 million increase in the average balance of these funds.

The decrease in interest income was more than offset by a $1.0 million decrease in interest expense for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019. The cost of interest-bearing deposits decreased 18 basis points between the periods, as a combined result of the declining interest rate environment and an increase in lower-cost demand deposits. Growth in our branch network allowed us to reduce our dependency on higher cost brokered deposits. Interest expense on these brokered funds decreased by $813,000 for the six months ended June 30, 2020, as compared to the same period in 2019, primarily as a result of a $63.4 million decrease in their average balance.

Further contributing to the decrease in interest expense, borrowing interest expense decreased by $912,000 for the six months ended June 30, 2020, as compared to the same period in 2019. As a result of the declining interest rate environment, our cost of borrowings decreased 99 basis points to 1.28% for the six months ended June 30, 2020, from 2.27% for the six months ended June 30, 2019. Growth in lower cost demand deposits allowed us to decrease our use of FHLB Fed Funds, thereby reducing our average balance of borrowings by $25.5 million for the six months ended June 30, 2020, as compared to the same period in 2019.

The Company’s net interest margin decreased to 3.12% for the six months ended June 30, 2020, from 3.30% for the six months ended June 30, 2019, primarily due to decreases in our yield on interest earning assets outpacing the decrease in cost of interest-bearing liabilities. For more information on this, see “How We Measure the Risk of Interest Rate Changes” in Item 3 of this report.

54

The following table details the change in net interest income due to changes in yield or cost, or changes in the average balance of the related asset or liability:

	Six Months Ended June 30, 2020 Compared to June 30, 2019 Net Change in Interest
	Rate		Volume		Total
	(In thousands)
Interest-earning assets:
Loans receivable, net	$	(1,972)	$	1,742	$	(230)
Investments available-for-sale	(470)		(83)		(553)
Investments held-to-maturity	11		—		11
Interest-earning deposits with banks	(211)		160		(51)
FHLB stock	(12)		(24)		(36)
Total net change in income on interest-earning assets	(2,654)		1,795		(859)
Interest-bearing liabilities:
Interest-bearing demand	73		27		100
Statement savings	(2)		(4)		(6)
Money market	(515)		598		83
Certificates of deposit, retail	124		392		516
Certificates of deposit, brokered	(59)		(754)		(813)
Borrowings	(626)		(286)		(912)
Total net change in expense on interest-bearing liabilities	(1,005)		(27)		(1,032)
Total net change in net interest income	$	(1,649)	$	1,822	$	173

55

The following table compares detailed average balances, associated yields and rates, and the resulting changes in interest and dividend income or expense for the six months ended June 30, 2020 and 2019. Nonaccrual loans are included in the average balance of net loans receivable and are considered to carry a zero yield.

	Six Months Ended June 30,
	2020						2019
	Average Balance		Interest Earned / Paid		Yield or Cost		Average Balance		Interest Earned / Paid		Yield or Cost
	(Dollars in thousands)
Assets
Loans receivable, net	$	1,109,502	$	26,657	4.83	%	$	1,041,999	$	26,887	5.20	%
Investments available-for-sale	134,402		1,715		2.57		139,529		2,268		3.28
Investments held-to-maturity	2,219		11		1.00
Interest-earning deposits with banks	20,772		37		0.36		7,384		88		2.40
FHLB stock	6,676		157		4.73		7,611		193		5.11
Total interest-earning assets	1,273,571		28,577		4.51		1,196,523		29,436		4.96
Noninterest earning assets	74,486						72,926
Total average assets	$	1,348,057					$	1,269,449
Liabilities and Stockholders' Equity
Interest-bearing demand	$	77,128	$	142	0.37	%	$	46,880	$	42	0.18	%
Statement savings	17,578		9		0.1		23,750		15		0.13
Money market	397,357		2,327		1.18		313,729		2,244		1.44
Certificates of deposit, retail	435,434		4,990		2.30		400,339		4,474		2.25
Certificates of deposit, brokered	52,309		564		2.17		115,691		1,377		2.40
Total interest-bearing deposits	979,806		8,032		1.65		900,389		8,152		1.83
Borrowings	127,930		814		1.28		153,381		1,726		2.27
Total interest-bearing liabilities	1,107,736		8,846		1.61		1,053,770		9,878		1.89
Noninterest bearing liabilities	84,518						63,122
Average equity	155,803						152,557
Total average liabilities and equity	$	1,348,057					$	1,269,449
Net interest income			$	19,731					$	19,558
Net interest margin					3.12	%					3.30	%

Provision for Loan Losses. During the six months ended June 30, 2020, management evaluated the adequacy of the ALLL and concluded that a provision for loan losses in the amount of $600,000 was appropriate for the period. The additional provision was due primarily to COVID-19 related adjustments to economic factors considered in evaluating the ALLL against the probably losses inherent in the loan portfolio. Higher adjustments were made for our commercial real estate and construction/land portfolios to reflect the worsening impact to these industries from the COVID-19 pandemic. In comparison, for the six months ended June 30, 2019, a recapture of provision for loan losses of $400,000 was primarily the result of a construction loan with a balance of $11.6 million that was technically in default and classified as impaired, however, the Bank’s impairment analysis concluded there were no anticipated losses from the loan at this time, and therefore, allowance previously allocated in the ALLL to this loan were recaptured.

56

The following table summarizes selected financial data related to our ALLL and loan portfolio. All loan balances and ratios are calculated using loan balances that are net of LIP.

	At or For the Six Months Ended June 30,
	2020			2019
	(Dollars in thousands)
Total loans receivable, end of period	$	1,154,132		$	1,066,301
Average loans receivable during period	1,109,502			1,041,999
ALLL balance at beginning of period	13,218			13,347
Provision (recapture of provision) for loan losses	600			(400)
Charge-offs:
Total charge-offs	—			—
Recoveries:
One-to-four family	18			28
Multifamily	—			45
Consumer	—			37
Total recoveries	18			110
Net recovery	18			110
ALLL balance at end of period	$	13,836		$	13,057
ALLL as a percent of total loans	1.20		%	1.22		%
Ratio of net recoveries to average net loans receivable	—			0.01

        Noninterest Income. Noninterest income increased by $199,000 to $1.8 million for the six months ended June 30, 2019, as compared to $1.6 million for the same period in 2019. The following table provides a detailed analysis of the changes in the components of noninterest income:

	Six Months Ended June 30, 2020		Change from Six Months Ended June 30, 2019		Percent Change
	(Dollars in thousands)
Net gain on sale of investments	$	69	$	77	(962.5)	%
BOLI change in cash surrender value	509		51		11.1
Wealth management revenue	348		(109)		(23.9)
Deposit related fees	359		(17)		(4.5)
Loan related fees	489		217		79.8
Other	4		(20)		(83.3)
Total noninterest income	$	1,778	$	199	12.6	%

Noninterest income from loan related fees increased by $217,000 for the six months ended June 30, 2020, as compared to the same period in 2019, as a result of a $309,000 increase in loan prepayment fees on certain commercial loans. This was partially offset by an $87,000 decrease in interest rate swap fees received on loans where certain commercial loan customers participate in an interest rate swap with a third party broker institution and the Bank receives a fee that is recognized as other noninterest income at the time the loan is originated. Further contributing to the increase, sales of available-for-sale investments generated a $69,000 gain for the six months ended June 30, 2020, as compared to an $8,000 loss for the six months ended June 30, 2019. Partially offsetting these increases, wealth management revenue decreased $109,000 for these comparative periods. Although the assets managed by the Bank’s wealth management team have grown, the timing and nature of trailing revenue creates fluctuations in revenue.

57

Noninterest Expense. Noninterest expense increased $1.2 million to $16.2 million for the six months ended June 30, 2019, as compared to $15.0 million for the same period in 2019.

The following table provides a detailed analysis of the changes in the components of noninterest expense:

	Six Months Ended June 30, 2020		Change from Six Months Ended June 30, 2019		Percent Change
	(Dollars in thousands)
Salaries and employee benefits	$	10,013	$	279	2.9	%
Occupancy and equipment	2,103		339		19.2
Professional fees	885		63		7.7
Data processing	1,381		466		50.9
OREO-related expenses, net	6		(26)		(81.3)
Regulatory assessments	271		(2)		(0.7)
Insurance and bond premiums	223		30		15.5
Marketing	93		(69)		(42.6)
Other general and administrative	1,236		139		12.7
Total noninterest expense	$	16,211	$	1,219	8.1	%

The primary contributor to the increase in noninterest expense was our continued branch expansion. Salaries and employee benefits expense increased by $279,000 for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019, due to increased staffing in support of the new branches. In addition, occupancy and equipment expenses increased by $339,000 with our growth to twelve branch locations at June 30, 2020. Further, data processing expense increased by $466,000 as a combined result of increased loan and deposit transaction volume, and the implementation of a new online banking platform, as discussed above.

        Partially offsetting these increases, marketing expense decreased $69,000 for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019, due primarily to cancellations of sponsored events due to COVID-19 restrictions.

        Federal Income Tax Expense. Income before federal income taxes decreased by $1.8 million for the six months ended June 30, 2020, as compared to the same period in 2019, resulting in a reduction in federal income tax expense of $425,000. In addition, the effective tax rate was reduced for the six months ended June 30, 2020 as a result of the impact to certain stock compensation from a reduction in the Company’s stock price.

58

Liquidity

We are required to have enough cash flow in order to maintain sufficient liquidity to ensure a safe and sound operation. We maintain cash flows above the minimum level believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. On a daily basis, we review and update cash flow projections to ensure that adequate liquidity is maintained.

Our primary sources of funds are customer deposits, cash flow from the loan and investment portfolios, advances from the FHLB, and brokered certificates of deposit. These funds, together with equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. At June 30, 2020, retail certificates of deposit of $251.1 million and brokered certificates of deposit of $17.4 million were scheduled to mature in one year or less. Management’s practice is to maintain deposit rates at levels that are competitive with other local financial institutions. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by the level of interest rates, economic conditions and competition. We measure our liquidity based on our ability to fund our assets and to meet liability obligations when they come due. Liquidity (and funding) risk occurs when funds cannot be raised at reasonable prices or in a reasonable time frame to meet our normal or unanticipated obligations. We regularly monitor the mix between our assets and our liabilities to manage effectively our liquidity and funding requirements.

The COVID-19 pandemic may impact cash flow due to payment deferrals granted to borrowers who have been negatively impacted by the pandemic. To support the origination of PPP loans, the Board of Governors of the Federal Reserve System authorized the Paycheck Protection Program Lending Facility (“PPPLF”) to supply liquidity to participating financial institutions through term financing on a non-recourse basis at a rate of 35 basis points, with PPP loans as collateral at face value. The maturity date of this extension of credit will equal the maturity date of the pledged PPP loan. While we currently do not intend to use the PPPLF, as we held a substantial cash and cash equivalent position as a result of PPP disbursed funds remaining unused in borrower deposit accounts and due to growth in our deposit liabilities, we do have this and additional borrowings available to us from the FRB.

When deposits are not readily available and/or cost effective to provide the funds for our assets, we use alternative funding sources. These sources include but are not limited to: advances from the FHLB or the FRB, which are collateral dependent, wholesale funding, national certificates of deposit listing services, brokered deposits, federal funds purchased and dealer repurchase agreements, as well as other short-term alternatives. We may also liquidate assets to meet our funding needs. The balance of our investments available-for-sale decreased $7.7 million to $128.9 million at June 30, 2020, from $136.6 million at December 31, 2019, and represents a ready source of cash if needed. The balance of our interest-earning deposits with banks increased by $53.4 million to $66.3 million at June 30, 2020, from $12.9 million at December 31, 2019, as a result of increased retail deposits. At June 30, 2020, the Bank maintained credit facilities with the FHLB totaling $598.9 million, subject to qualifying collateral limits that reduced our pledged collateral capacity to $496.3 million, with an outstanding balance of $120.0 million. As further funding sources, we also had the ability to borrow $84.0 million from the FRB from loan programs other than the PPPLF, and $75.0 million from lines of credit with other financial institutions, with no balance outstanding from these sources at June 30, 2020. For additional information, see the Consolidated Statements of Cash Flows in Item 1 of this Form 10-Q.

        To assist in our funds acquisition and interest rate risk management efforts, management utilizes the national brokered deposit market and maintained a balance at June 30, 2020, of $32.4 million of brokered certificates of deposit. In contrast to most retail certificate of deposit offerings which provide the depositor with an option to withdraw their funds prior to maturity, subject to an early withdrawal penalty, certificates of deposit acquired in the brokered market limits the depositor ability to withdraw the funds before the end of the term (except in the case of death or adjudication of incompetence of a depositor) which greatly reduces early redemption risk compared to retail deposits. At June 30, 2020, brokered certificates of deposit had a remaining maturity of one month to 4.8 years. Some of these certificates also provide the Bank the option to redeem the deposit after six months, a favorable distinction compared to retail certificate of deposit terms that are offered in our local market. During the six months ended June 30, 2020, the Bank redeemed $9.5 million of callable brokered certificates of deposit with a weighted average remaining maturity of nine months. With these redemption limitations and call features, the cost of these brokered deposits is generally higher than our retail certificate of deposit offerings. Consequently, if we increase our brokered deposits, our cost of funds may increase.

        First Financial Northwest is a separate legal entity from the Bank and, on a stand-alone level, must provide for its own liquidity and pay its own operating expenses and cash dividends. First Financial Northwest's primary sources of funds consist of dividends from the Bank, although there are regulatory requirements related to the ability of the Bank to pay dividends. At June 30, 2020, the Company (on an unconsolidated basis) had liquid assets of $15.8 million and short-term liabilities of $216,000.

59

        On a monthly basis, we estimate our future liquidity sources and needs. Also, we determine funding concentrations and our need for sources of funds other than deposits. This information is used by our Asset/Liability Management Committee (“ALCO”) in forecasting funding needs and investing opportunities. We believe that our current liquidity position and our expected operating results are sufficient to fund all of our existing commitments.

Commitments and Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and the unused portions of lines of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Commitments to extend credit and lines of credit are not recorded as an asset or liability by us until the instrument is exercised. At June 30, 2020 and December 31, 2019, we had no commitments to originate loans for sale.

        Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the loan agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by us upon the extension of credit, is based on our credit evaluation of the customer. The amount and type of collateral required varies but may include real estate and income-producing commercial properties.

The following table summarizes our outstanding commitments to originate loans, advance additional amounts pursuant to outstanding lines of credit and to disburse funds related to our construction loans at June 30, 2020:

			Amount of Commitment Expiration
	Total Amounts Committed		Through One Year		After One Through Three Years		After Three Through Five Years		After Five Years
	(In thousands)
Commitments to originate loans	$	581	$	581	$	—	$	—	$	—
Unused portion of lines of credit	35,081		4,896		6,798		5,416		17,971
Undisbursed portion of construction loans	78,938		21,410		57,528		—		—
Total commitments	$	114,600	$	26,887	$	64,326	$	5,416	$	17,971

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

        As of June 30, 2020, the Bank had twelve operating leases with remaining terms of 2 months to 5.2 years which carry minimum lease payments of $57,000 per month. All of the lease agreements offer extension periods.

First Financial Northwest and its subsidiaries from time to time are involved in various claims and legal actions arising in the ordinary course of business. There are currently no claims and legal actions that in the opinion of management would have a material adverse effect on First Financial Northwest’s consolidated financial position, results of operation, or liquidity.

60

Capital

At June 30, 2020, stockholders’ equity totaled $154.0 million, or 10.9% of total assets. Our book value per share of common stock was $15.32 at June 30, 2020, compared to $15.25 at December 31, 2019. Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well-capitalized” status in accordance with regulatory standards.

As of June 30, 2020, the Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory capital guidelines of the FDIC. The following table provides the Bank’s capital requirements and actual results.

	At June 30, 2020
	Actual				For Minimum Capital Adequacy Purposes				To be Categorized as “Well Capitalized”
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
Tier I leverage capital (to average assets)	$	137,308	10.02	%	$	54,811	4.00	%	$	68,514	5.00	%
Common equity tier I ("CET1") (to risk- weighted assets)	137,308		13.70		45,100		4.50		65,144		6.50
Tier I risk-based capital (to risk-weighted assets)	137,308		13.70		60,133		6.00		80,177		8.00
Total risk-based capital (to risk-weighted assets)	149,857		14.95		80,177		8.00		100,222		10.00

In addition to the minimum CET1, Tier I total capital and leverage ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. At June 30, 2020, the Bank’s capital conservation buffer was 6.95%.

61

Item 3. Quantitative and Qualitative Disclosures about Market Risk

General. Our Board of Directors has approved an asset/liability management policy to guide management in maximizing interest rate spread by managing the differences in terms between interest-earning assets and interest-bearing liabilities while maintaining acceptable levels of liquidity, capital adequacy, interest rate risk, credit risk, and profitability. The policy established an Investment, Asset/Liability Committee (“ALCO,”) comprised of certain members of senior management and the Board of Directors. The Committee’s purpose is to communicate, coordinate and manage our asset/liability position consistent with our business plan and Board-approved policies. The ALCO meets quarterly to review various areas including:

•economic conditions;

•interest rate outlook;

•asset/liability mix;

•interest rate risk sensitivity;

•current market opportunities to promote specific products;

•historical financial results;

•projected financial results; and

•capital position.

        The Committee also reviews current and projected liquidity needs. As part of its procedures, the Committee regularly reviews interest rate risk by forecasting the impact that changes in interest rates may have on net interest income and the market value of portfolio equity, which is defined as the net present value of an institution’s existing assets, liabilities and off-balance sheet instruments and evaluating such impacts against the maximum potential change in the market value of portfolio equity that is authorized by the Board of Directors.

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Our loans generally have longer maturities than our deposits. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

We have utilized the following strategies in our efforts to manage interest rate risk:

•we are originating shorter term higher yielding loans, whenever possible;

•we have attempted, where possible, to extend the maturities of our deposits which typically fund our long-    term assets;    

•we have invested in securities with relatively short average lives, generally less than eight years;

•we have added adjustable-rate loans to our loan portfolio;

•we utilize brokered certificates of deposit with a call option as a funding source; and

•we have utilized interest rate swaps to effectively fix the rate on certain FHLB advances.

        We have evaluated the use of derivative instruments to limit the impact of interest rate changes on earnings and cash flows and to lower our cost of borrowing while taking into account various elements of interest rate risk. We are using interest rate swaps which qualify as a cash flow hedge as a tool to lower the cost of certain FHLB advances as compared to the fixed rates offered by the FHLB for its longer term advances. At June 30, 2020, the Bank held six interest rate swap agreements with a total notional amount of $120.0 million and a weighted-average fixed interest rate of 1.22%. Under the interest rate agreements, the Bank pays a fixed interest rate, and receives a floating rate based on 1-month or 3-month LIBOR rates to coincide with each agreement’s reset frequency for an original term of four to eight years. Concurrently at the onset of each interest rate agreement, the Bank secured a fixed rate FHLB advance that resets to market rate on the same cycle as the corresponding interest rate swap agreement. In addition, the Bank has entered into two, forward starting interest rate swap agreements with a start date of October 25, 2021, a total notional amount of $25.0 million, and a weighted-average interest rate of 0.80%. These interest rate agreements are intended to partially replace the $50.0 million notional amount interest rate swap that matures on that date. Entering into these agreements has allowed the Bank to secure fixed rate funding at a lower cost than

62

a traditional five-year fixed rate FHLB advance. We will continue to review similar instruments and may continue to utilize them for interest rate risk management in the future.

        Interest rate contracts, however, may expose us to the risk of loss associated with variations in the spread between the interest rate contract and the hedged item. In addition, these contracts carry volatility risk that the expected uncertainty relating to the price of the underlying asset differs from what is anticipated. If any interest rate swap we enter into proves ineffective, it could result in volatility in our operating results, including potential losses, which could have a material adverse effect on our results of operations and cash flows.

Brokered Deposits. Management utilizes the national brokered deposit market as an additional source of funds and to assist efforts in managing interest rate risk. Utilizing brokered deposits might result in increased regulatory scrutiny, as such deposits are not viewed as favorably as core retail deposits and there can be no assurance that the Bank will be allowed to include brokered deposits in its deposit mix in the future. While management will attempt to weigh the benefits of brokered deposits against the costs and risks, there can be no assurance that its conclusions will necessarily be aligned with those of the Bank’s regulators.

How We Measure the Risk of Interest Rate Changes. We monitor our interest rate sensitivity on a quarterly basis by measuring the impact of changes to net interest income in multiple rate environments. Management retains the services of a third party consultant with nearly 40 years of experience in asset-liability management to assist in its interest rate risk and asset-liability management. Management uses various assumptions to evaluate the sensitivity of the market value of our assets and liabilities to changes in interest rates. Although management believes these assumptions are reasonable, the interest rate sensitivity of our assets and liabilities on net interest income and the market value of portfolio equity could vary substantially if different assumptions were used or actual results differ from these assumptions. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react differently to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities lag behind changes in market interest rates. Non-uniform changes and fluctuations in market interest rates across various maturities will also affect the results presented. In addition, certain assets, such as adjustable-rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, a portion of our adjustable-rate loans have interest rate floors below which the loan’s contractual interest rate may not adjust in conjunction with market rates. Approximately 44.1% of our total loans were adjustable-rate loans at June 30, 2020. At that date, $402.8 million, or 79.1% of these loans were at their floor, with a weighted-average interest rate of 4.73%. A portion of these loans are set to reprice at defined time intervals. However, of our adjustable rate loans, $138.5 million are based on prime rate plus a specified margin, and recalculate each time the prime rate changes. For these prime based loans where the floor rate is currently above the loan’s fully indexed rate, the Bank will not receive the benefit of an increasing market rates until prime rate increases enough where the fully indexed rate exceeds the loans floor rate. At June 30, 2020, the Bank’s net loans receivable included $138.5 million of prime based loans, of which $124.7 million were at a floor rate that exceeded their fully indexed rate. The following table shows the rate increase that would need to occur on these loans before the Bank receives the benefit of a floating rate:

	June 30, 2020
Increase in prime rate:	(Dollars in thousands)
0 - 25 bps	$	5,584
26 - 50 bps	2,076
51 - 75 bps	8,060
76 - 100 bps	30,474
101 - 150 bps	26,858
151 - 200 bps	19,262
> 200 bps	32,410
	124,724

        The inability of our loans to adjust downward can contribute to increased income in periods of declining interest rates, although this result is subject to the risk that borrowers may refinance these loans during periods of declining interest rates. However, when loans are at their floors, there is a further risk that our interest income may not increase as rapidly as our cost of funds during periods of increasing interest rates. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. We consider all these factors in monitoring our interest rate exposure.

63

The assumptions we use to monitor interest rate risk are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, loan prepayments, deposit decay rates and the market value of certain assets under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposit rates can be maintained with rate adjustments proportionate to the change in market interest rates, based upon our historical deposit decay rates, which are substantially lower than market decay rates. We have observed in the past that our deposit accounts during changing rate environments have relatively lower volatility and less than market rate changes. When interest rates rise, we do not have to raise interest rates proportionately on less rate sensitive accounts to retain these deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience. In the event of a significant change in interest rates, however, prepayment and early withdrawal levels would likely deviate from those assumed.

Our income simulation model examines changes in net interest income in which interest rates were assumed to remain at their base level, instantaneously increase by 100, 200 and 300 basis points or decline immediately by 100 basis points. A decline by 200 or 300 basis points were not reported as the current targeted federal funds rate is between 0.00% and 0.25%.

The following table illustrates the estimated change in our net interest income over the next 12 months from June 30, 2020, that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that the Bank might take to counter the effect of that interest rate movement.

Net Interest Income Change at June 30, 2020
Basis Point Change in Rates	Net Interest Income	% Change
(Dollars in thousands)
+300	$40,710	3.64%
+200	39,932	1.66
+100	39,496	0.55
Base	39,280	—
(100)	40,983	4.34

The following table illustrates the change in our net portfolio value (“NPV”) at June 30, 2020, that would occur in the event of an immediate change in interest rates equally across all maturities, with no effect given to any steps that we might take to counter the effect of that interest rate movement.

Basis Point							Net Portfolio as % of				Market
Change in	Net Portfolio Value (1)						Portfolio Value of Assets				Value of
Rates	Amount		$ Change (2)		% Change		NPV Ratio (3)		% Change (4)		Assets (5)
	(Dollars in thousands)
+300	$	117,686	$	(34,259)	(22.55)	%	8.90	%	(2.42)	%	$	1,322,819
+200	128,527		(23,418)		(15.41)		9.51		(1.65)		1,351,813
+100	142,326		(9,619)		(6.33)		10.28		(0.68)		1,384,902
Base	151,945		—		—		10.74		—		1,415,065
(100)	146,018		(5,927)		(3.90)		10.27		(0.42)		1,421,730

_____________ 

⁽¹⁾ The net portfolio value is the difference between the present value of the discounted cash flows of assets and liabilities and represents the market value of the Company’s equity for any given interest rate scenario. Net portfolio value is useful for determining, on a market value basis, how the market value of equity changes in response to various interest rate scenarios. Large changes in net portfolio value reflect increased interest rate sensitivity and generally more volatile earnings streams.

⁽²⁾ The increase or decrease in net portfolio value at the indicated interest rates compared to the net portfolio value assuming no change in interest rates.

64

⁽³⁾ Net portfolio value divided by the market value of assets.

⁽⁴⁾ The increase or decrease in the net portfolio value divided by the market value of assets.

⁽⁵⁾ The market value of assets represents the value of assets under the various interest rate scenarios and reflects the sensitivity of those assets to interest rate changes.

The net interest income and net portfolio value tables presented above are predicated upon a stable balance sheet with no growth or change in asset or liability mix. In addition, the net portfolio value is based upon the present value of discounted cash flows using our estimates of current replacement rates to discount the cash flows. The effects of changes in interest rates in the net interest income table are based upon a cash flow simulation of our existing assets and liabilities and assuming that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. Delinquency rates may change when interest rates change as a result of changes in the loan portfolio mix, underwriting conditions, loan terms or changes in economic conditions that have a delayed effect on the portfolio. Even if interest rates change in the designated amounts, there can be no assurance that our assets and liabilities would perform as set forth above. Also, a change in U.S. Treasury rates in the designated amounts accompanied by a change in the shape of the Treasury yield curve would cause changes to the net portfolio value and net interest income other than those indicated above.

At June 30, 2020, other than the interest rate swap agreements we have entered into, we did not have any derivative financial instruments or trading accounts for any class of financial instruments, nor have we engaged in any other hedging activities or purchased off-balance sheet derivative instruments. However, we continue to review such instruments and may utilize them for interest rate risk management in the future. Interest rate risk continues to be one of our primary risks, as other types of risks, such as foreign currency exchange risk and commodity pricing risk do not arise in the normal course of our business activities and operations.

Item 4. Controls and Procedures

        The management of First Financial Northwest, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 (“Exchange Act”). A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Also, because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Additionally, in designing disclosure controls and procedures, our management was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. As a result of these inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Furthermore, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

(a)Evaluation of Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) was carried out under the supervision and with the participation of our Chief Executive Officer, Chief Financial Officer (Principal Financial Officer) and several other members of our senior management as of the end of the period covered by this report. Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2020, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is (i) accumulated and communicated to our management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b)Changes in Internal Controls: In the quarter ended June 30, 2020, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

65

PART II

Item 1. Legal Proceedings

From time to time, we are engaged in various legal proceedings in the ordinary course of business, none of which are currently considered to have a material impact on our financial position or results of operations.

Item 1A. Risk Factors

        In light of recent developments relating to Coronavirus Disease 2019 (“COVID-19”), the Company is supplementing its risk factors contained in Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on March 12, 2020. The following risk factor should be read in conjunction with the risk factors described in the Annual Report on Form 10-K.

        The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our customers. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

        The COVID-19 pandemic has significantly adversely affected our operations and the way we provide banking services to businesses and individuals, most of whom were under government issued stay-at-home orders for much of the three months ended June 30, 2020. As an essential business, we continue to provide banking and financial services to our customers at all of our branch locations. In addition, we continue to provide access to banking and financial services through online banking, ATMs and by telephone. If the COVID-19 pandemic worsens it could limit or disrupt our ability to provide banking and financial services to our customers.

        The stay-at-home order was lifted, however, some of our employees continue to work remotely to enable us to continue to provide banking services to our customers. Heightened cybersecurity, information security and operational risks may result from these remote work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. We also rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.

        There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations, other than through government sponsored programs such as the Payroll Protection Program, deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including a continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality, leisure and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.

        The impact of the pandemic is expected to continue to adversely affect us during 2020 and possibly longer as the ability of many of our customers to make loan payments has been significantly affected. Although the Company makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio. It is likely that loan delinquencies, adversely classified loans and loan charge-offs will increase in the future as a result of the pandemic. Consistent with guidance provided by banking regulators, we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is

66

resolved. Any increases in the allowance for credit losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.

        In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition.

        Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its effects, the length of which is unknown. and during which we may experience a recession. As a result, we anticipate our business may be materially and adversely affected during this recovery. To the extent the effects of the COVID-19 pandemic adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in our 2019 Annual Report on Form 10-K and any subsequent Quarterly Reports on Form 10-Q. 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a)  Not applicable

(b)  Not applicable

(c) The following table summarizes First Financial Northwest’s common stock repurchases during the three months ended June 30, 2020:

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Repurchased as Part of Publicly Announced Plan	Maximum Number of Shares that May Yet Be Repurchased Under the Plan
April 1 - April 30, 2020	—	$	—	—	433,605
May 1 - May 31, 2020	68,600	9.13		68,600	365,005
June 1 - June 30, 2020	66,850	9.72		66,850	298,155
	135,450	9.42		135,450	298,155

        On January 6, 2020, the Board of Directors authorized the repurchase of up to 513,000 shares of the Company’s common stock, or approximately 5% of the Company’s outstanding shares. The plan allowed for the repurchase from January 27, 2020 through July 27, 2020, on the open market or in privately negotiated transactions, in accordance with Rule 10b-18 of the Securities and Exchange Act of 1934, as amended. At June 30, 2020, the Company had repurchased 214,845 shares authorized for repurchase at an average price of $11.13 per share.

Item 3. Defaults Upon Senior Securities

        Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

67

Item 6. Exhibits and Financial Statement Schedules

(a)       Exhibits

3.1	Articles of Incorporation of First Financial Northwest (1)
3.2	Amended and Restated Bylaws of First Financial Northwest (2)
4.1	Form of stock certificate of First Financial Northwest (1)
10.1	Amended Employment Agreement between First Financial Northwest Bank and Joseph W. Kiley III (3)
10.2	Form of Change in Control Severance Agreement for Executive Officers (4)
10.3	Amended Executive Supplemental Retirement Plan Participation Agreement with Joseph W. Kiley III (5)
10.4	2008 Equity Incentive Plan (6)
10.5	2016 Equity Incentive Plan (7)
10.6	Forms of incentive and non-qualified stock option award agreements under the 2008 Equity Incentive Plan (8)
10.7	Form of restricted stock award agreement under the 2008 Equity Incentive Plan (8)
10.8	Employment Agreement between First Financial Northwest Bank and Richard P. Jacobson (2)
10.9	Form of restricted stock award agreement under the 2016 Equity Incentive Plan (9)
10.10	Form of incentive stock option award agreement under the 2016 Equity Incentive Plan (10)
10.11	Form of non-qualified stock option award agreement under the 2016 Equity Incentive Plan (10)
10.12	Form of restricted stock award agreement under the 2016 Equity Incentive Plan (11)
10.13	Offer letter for Randy T. Riffle (12)
10.14	Form of Involuntary Termination Agreement with Randy T. Riffle (13)
10.15	Form of Change in Control Severance Agreement with Randy T. Riffle (13)
10.16	Supplemental Executive Retirement Plan Agreement for Joseph W. Kiley III (14)
10.17	Supplemental Executive Retirement Plan Agreement for Richard P. Jacobson (15)
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101	The following materials from First Financial Northwest’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Income Statements; (3) Consolidated Statements of Comprehensive Income; (4) Consolidated Statements of Stockholders’ Equity; (5) Consolidated Statements of Cash Flows; and (6) Selected Notes to Consolidated Financial Statements.

 _____________

⁽¹⁾Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-1 on June 6, 2007 (333-143539)

⁽²⁾Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated May 15, 2020.

⁽³⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 5, 2013.

⁽⁴⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated September 9, 2014.

⁽⁵⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 15, 2020.

⁽⁶⁾ Filed as Appendix A to First Financial Northwest’s definitive proxy statement dated April 15, 2008.

⁽⁷⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated June 15, 2016.

⁽⁸⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated July 1, 2008.

⁽⁹⁾ Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for March 31, 2018 filed on May 8, 2018.

⁽¹⁰⁾ Filed as an exhibit to First Financial Northwest’s Registration Statement on Form S-8 on June 15, 2016 (333-212029)

⁽¹¹⁾ Filed as an exhibit to First Financial Northwest’s Quarterly Report on Form 10-Q for September 30, 2018 filed November 7, 2018.

⁽¹²⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated December 20, 2018.

⁽¹³⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 3, 2019.

⁽¹⁴⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 15, 2020.

⁽¹⁵⁾ Filed as an exhibit to First Financial Northwest’s Current Report on Form 8-K dated January 15, 2020.

68

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	FIRST FINANCIAL NORTHWEST, INC.
Date: August 7, 2020	By:	/s/Joseph W. Kiley III
		Joseph W. Kiley III
		President and Chief Executive Officer (Principal Executive Officer)

Date: August 7, 2020	By:	/s/Richard P. Jacobson
		Richard P. Jacobson
		Executive Vice President and Chief Financial Officer (Principal Financial Officer)
Date: August 7, 2020	By:	/s/Christine A. Huestis
		Christine A. Huestis
		First Vice President and Controller (Principal Accounting Officer)

69